The dollar is stabilising this morning, but is still headed for a weekly loss after yesterday’s US consumer price index report showed inflation easing even more than markets had expected, triggering a stampede into risk-sensitive assets. Two- and ten-year yields are inching higher after falling to their lowest since March, equity futures are setting up for a more positive open after experiencing a violent sectoral rotation – the Russell 2000 small-cap index advanced by the most against the Nasdaq 100 since November 2020 – and currency markets are entering a consolidative phase. The pound and euro are both adding to their gains amid a lack of domestic trading cues, the Canadian dollar is appreciating on a narrowing in yield spreads, and the Chinese yuan – firmly on the defensive for months – is pushing off the bottom of its trading range.

A surprise decline in housing costs provided much of the relief, decelerating sharply after contributing more than 62 percent of the increase in the consumer price index over the last twelve months. After failing to ease earlier in the year, the rent and largely theoretical “owners’ equivalent rent” categories slowed from 0.42 percent to 0.27 percent on a month-over-month basis as data-collection problems were resolved, bringing shelter cost increases down to 2.1 percent on an annualised basis from 4.9 percent in May. Inflation in services categories flatlined, and core goods were in negative territory, generating a -0.1 percent month-over-month decline in the all-items index.

Today’s producer price index release is likely to arrive at similar conclusions, helping ratify expectations for a soft core personal consumption expenditures print later in the month.

The early year panic over a re-acceleration in US growth and inflation rates now looks overdone. If price pressures remain tame, and labour markets keep softening, it is likely that the first signs of dovish dissents begin emerging among Federal Reserve officials, putting Jerome Powell on course toward telegraphing a September rate cut at the Jackson Hole Economic Symposium in late August. The Chicago Fed’s Austan Goolsbee – admittedly on the more accommodative end of the spectrum – yesterday said “The committee put out a statement saying, we would not anticipate cutting rates until we were more convinced we’re on a path to 2 percent. My view is that this is what the path to 2 percent looks like.”

Odds on a cut at the September Fed meeting are holding near the 90 percent level, and the likelihood of three moves this year has risen substantially, with November looking like a live meeting, despite its proximity to the presidential election. This week’s rapid narrowing in expected growth differentials has translated into a slightly steeper drop in US yields than elsewhere, but market-implied policy projections are still managing to move in relative synchrony, limiting the impact on exchange rates.

It looks as if Japanese authorities intervened in currency markets yesterday. The yen jumped by far more than its global counterparts in the hours after the US inflation report landed – far outstripping the underlying improvement in forward differentials – suggesting that the Bank of Japan saw an opportunity to magnify the impact of its buying activity by hitting short-sellers when they were at their most vulnerable. There‘s been no official confirmation, but two Japanese media outlets – TV Asahi and the Mainichi Shimbun – quoted anonymous government sources confirming intervention, and traders at some banks reported receiving “rate checks” – in which the Bank asks for quotes on both sides of the market.

We doubt this will sound the death knell for the yen-funded carry trade. The trade – which involves borrowing in low-yielding yen and investing in high-yielding currencies elsewhere in the world – remains extremely attractive even after several Japanese intervention attempts and a series of political shocks in countries like Mexico – where interest rates remain vastly higher. Until global markets take a hit big enough to bring the yen’s safe haven characteristics back into play, speculators are likely to keep picking up the proverbial nickels (more likely ¥10,000 notes) in front of steamrollers.

Next week’s economic calendar looks far less US-centric. Tuesday’s June retail sales report is the only major release scheduled, with headlines emerging from the Republican convention highly likely to swamp any market impact. In the United Kingdom, inflation and wage data could alter odds on a rate cut going into the Bank of England’s August decision, although the tea leaves we’re reading would suggest that a hold has become much more likely. An update in the European Central Bank’s bank lending survey will help shed light into whether signs of an upturn are becoming more entrenched, but policymakers are unlikely to be swayed in either direction ahead of Thursday’s meeting – a string of recent appearances suggests that officials expect to deliver more easing in the early autumn.

Here in Canada, a series of data releases could play a decisive role in determining whether the central bank delivers a rate cut on the 24th. On Monday, signs of continued economic malaise in the Bank of Canada’s latest Business Outlook and Consumer Expectations surveys might raise market expectations, with the June consumer price index print the next day having a similar effect. Economists are forecasting a steep decline in the month-over-month pace of all-items inflation, with the Bank’s preferred core measures continuing to cool. We’ll also be watching housing starts, due the same morning, and Friday’s retail sales print for evidence of renewed softness in household consumption.

Market-implied odds on a back-to-back move at the July meeting are currently holding at a remarkably-high 70 percent. We’re still inclined to think that September is more likely, but this is not a high-conviction view – as long-time readers know, we’ve been wary of interest rate sensitivities in the Canadian economy for longer than most, meaning that we certainly won’t be shocked if officials choose to move policy onto a less restrictive footing in the near term.