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Risk appetite falls on accumulating evidence of global economic slowdown

The dollar is staging a broad-based recovery this morning after a raft of purchasing manager surveys showed activity slowing sharply across a range of global economies. Data published by S&P this morning provided evidence of decelerating growth in Australia, Japan, the UK and the euro area, with the all-important services sector joining manufacturing in showing signs of strain in every major country.

In the euro area, the headline purchasing manager index dropped to 50.3 in June from 52.5 in the prior month, narrowly avoiding contraction and hitting a five-month low as the strike-plagued French economy deteriorated and the German factory sector remained depressed. European yields fell and the common currency slid as S&P said there was a “marked cooling in inflation pressures” – a development that could limit the need for additional rate hikes from the European Central Bank beyond a widely-anticipated move in July.

An equivalent measure for the United Kingdom remained in expansionary territory, but also came in below expectations, putting renewed pressure on the pound. Survey data and anecdotal evidence suggest yesterday’s surprising 50-basis point hike from the Bank of England hike could exacerbate pressure on businesses and households, pushing the economy into recession and limiting investment flows – even as yield differentials tilt in the pound’s favour. With the appeal of higher interest rates failing to offset fears of a downturn, the currency looks set to end the week firmly in negative territory.

S&P will release the same index for the US later this morning, and markets could react aggressively. If signs of softness in the services category emerge more clearly, investors will begin bracing for a drop in American consumer spending, with the attendant implications for growth and inflation helping to send medium-term rate expectations spiralling further down. The dollar – which possesses both safe haven and yield-hunting characteristics – could experience more volatility.

The Mexican peso is on the defensive after inflation slowed more than expected in early June and the central bank said it would stay on hold for an extended period of time. Broadly aligning with market expectations and previous commentary, policymakers kept rates unchanged in yesterday’s decision, saying “To achieve the orderly and sustained convergence of inflation to its 3 percent target, the board considers that it will be necessary to keep the interest rate at its current level for a prolonged period”. Data released earlier yesterday showed headline consumer prices rising 5.18 percent year-over-year in the first half of June, down from 5.67 percent in late May and below consensus forecasts. The peso remains one of the world’s best-performing major currencies, but relative rate differentials could soon begin to narrow if inflation pressures continue to subside.

Canada’s loonie is cruising toward a weekly loss after posting gains earlier in the week. Falling oil prices, coupled with a sustained rise in the big dollar seem to have inflicted most of the damage, but we suspect rate expectations are suffering some mean reversion after an outsized jump around the surprise Bank of Canada hike earlier in the month. Although signs of overheating remain clear and present, market veterans know that periods of relative outperformance in the Canadian economy tend to be fairly short-lived – and interest differentials may have narrowed unsustainably. 

In the docket next week: Central bankers will gather in Sintra, Portugal for an annual conference that typically generates headlines but has little meaningful impact on markets. Canada and Australia will deliver new consumer price indices, both the US and Canada will update gross domestic product numbers, and the Bank of Canada will publish its latest Business Outlook Survey. The euro area is likely to report another deceleration in headline inflation for the month of June, but the core measure may have moved stubbornly higher, limiting relief for the European Central Bank. And US personal consumption expenditures data should show solid declines from April, with weakening in the headline, core , and “supercore” measures helping ratify bets on a prolonged post-July pause from the Federal Reserve.

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