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Softer US data triggers capitulation across currency markets

The dollar is in retreat and currency markets are undergoing a broad-based realignment a day after data was released showing that policymakers might be close to pulling off an “immaculate disinflation” – in which price growth slows without triggering a big rise in unemployment. According to the numbers from the Bureau of Labor Statistics, headline inflation fell to 3 percent year-over-year and core price growth slipped to 4.8 percent in June. Perhaps more importantly, core consumer prices climbed at an annualized 1.9 percent month-over-month pace, with core goods turning negative and the core services category growing at its slowest pace in months.

Markets remain overwhelmingly convinced the Federal Reserve will raise rates again on July 26, but odds on a move in the latter half of the year are rapidly converging with zero. Although we also think the central bank’s tightening cycle is done, we suspect policymakers will follow in the Bank of Canada’s footsteps, using statement language and ongoing communication efforts to maintain a hawkish outlook on growth and inflation – if only to steer markets away from an undesired loosening in financial conditions.

The greenback is trading near a 15-month low – close to the levels that prevailed before the Fed began tightening rates in early 2022 – with virtually every other currency sitting on solid gains. The British pound is exchanging hands above the 1.30 threshold against the dollar for the first time in more than a year, the euro has breached several key resistance levels and looks positioned to break through 1.1185 to the topside, and the Canadian dollar is building on yesterday’s gains to push toward the last lines of defence above the 1.30 mark.

Even the yen – which tended to act as a risk proxy prior to the coronavirus pandemic – is rallying, pushing through the 139 mark against the dollar and posting its biggest weekly gain this year. Many believe that this is reflective of increasing conviction in a hawkish adjustment in the Bank of Japan’s yield curve control policy later this month, but Japanese interest rates aren’t exhibiting signs of upward torque – instead, a slow-motion short squeeze may be underway. We don’t detect the hand of the Ministry of Finance in driving price action, but the move does look suspiciously close to what we would see if intervention efforts were underway.

Taken more broadly, we suspect some of these trends could lose momentum in the days to come – tactical repositioning flows will run out of steam, a single month’s data hardly defines a trend, central banks are still far from declaring “mission accomplished” on inflation, and growth risks are likely to emerge as bigger market drivers over time – but the currency landscape looks dramatically altered nonetheless. The dollar looks likely to remain on the defensive against risk-sensitive currencies in the rest of the world for a few months yet, as befits its counter-cyclical role in global financial markets.

The number of initial claims for US jobless benefits fell to 237,000 in the week ended July 8, beating estimates for a print closer to the 250,000 mark, and bringing the 4-week moving average to 246,800 – numbers hardly indicative of stress in labour markets.

Producer prices – an important input into the personal consumption expenditures index targeted by the Fed – rose just 0.1 percent at the headline and core levels in June, reflecting softening demand and a drop in import costs. Expectations had been set closer to an already-low 0.2 percent on both levels.

Still ahead today: The San Francisco Fed’s Mary Daly will hit CNBC around 11 am and Governor Waller will deliver a speech on the economic outlook at 6:30 pm, marking some of the last appearances from central bank officials before the blackout period begins ahead of the July 25-26 meeting.

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