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Strong consumer demand and softening inflation bolster US “soft landing” hopes

With American households honouring their time-honoured role in acting as global consumers-of-last-resort and inflation pressures continuing to subside, financial markets are seeing a broad-based rise in risk-taking activity this morning. Equity futures are pointing to a strong open, the dollar is ticking lower, and high-beta currencies are outperforming after a raft of softer inflation data added to yesterday’s strong second-quarter growth print in suggesting that the US economy is shrugging off the impact of higher rates – and could continue to power global growth in the months to come.

The yen is up modestly and global yields are higher after the Bank of Japan wrongfooted markets by loosening its yield curve control framework – potentially dampening demand from Japanese investors for government debt in the rest of the world. 

North America

US consumer spending accelerated and the Federal Reserve’s preferred inflation measure cooled in June, helping to ratify bets on a “soft landing” in the economy. Data released by the Bureau of Economic Analysis this morning showed the core personal consumption expenditures index – targeted by the Fed – rising 0.2 percent in June from the prior month, up 4.1 percent year-over-year – in close alignment with consensus estimates. The overall personal consumption expenditures index was up just 3 percent from a year ago.

Personal income rose 0.3 percent month-over-month, decelerating from May’s 0.5-percent gain. Compensation was 5.7 percent higher relative to the same month last year, led by a 5.9 percent increase in private sector wages and salaries. Real consumer spending rose 0.4 percent month-over-month, up from 0.3 percent in May and indicative of a slight improvement in sentiment levels.

A separate indicator – the Employment Cost Index – showed wages and benefits rising 1 percent in the second quarter, slightly below consensus estimates that were set closer to 1.1 percent. Relative to a year earlier, employment costs – a critical measure of strength in the labour market – were up 4.5 percent, slower than the 4.8-percent pace posted in the first quarter.

Data out yesterday showed the US economy growing 2.4 percent on an annualised basis in the second quarter, crushing consensus forecasts that had been set closer to the 1.8 percent mark and bolstering bets on an “immaculate disinflation” in which price increases slow without triggering a sharp rise in unemployment. Consumer spending weakened somewhat, but business investment picked up the slack, and under-the-hood details pointed to relative stability in underlying growth drivers.

In contrast, a preliminary estimate showed the Canadian economy shrinking 0.2 percent on a month-over-month basis in June, suggesting that underlying momentum is weakening as higher borrowing costs begin to bite. Statistics Canada said output expanded 0.3 percent in May, with the real estate sector acting as the clear outperformer, adding to modest growth in the manufacturing and wholesale industries, and pairing with a post-strike rebound in the public sector to lift the headline number. On this trajectory, the economy will have grown roughly 0.9 percent in the second quarter, down sharply from 3.1 percent in the first three months of the year, and well below the cautiously-optimistic Bank of Canada’s 1.5-percent forecast.

The Canadian dollar is up slightly, with domestic drivers difficult to extricate from the wider market impact of US data releases. 

Later today, the University of Michigan’s second consumer sentiment estimate for July is seen holding at 72.6, unchanged from the preliminary reading. 


The euro remains sharply weaker after yesterday’s more dovish-than-anticipated European Central Bank decision coincided with strong US economic data to tilt rate differentials against the common currency. Officials elected to deliver a relatively-cautious outlook in the press release and post-decision press conference – bowing to a clear softening in economic data over the last month – and markets followed suit, downgrading the likelihood of another rate increase in the autumn months and pulling expected rate cuts forward into early 2024. In comments released this morning, Governing Council member Francois Villeroy de Galhau suggested that tighter monetary conditions were impacting the economy at a lag, saying “Given the time for this full transmission, perseverance is now the prime key virtue. Pragmatism is second – decisions at our next meetings will be open and entirely data driven”. From a technical perspective, the euro looks hemmed in between the 1.0850 and 1.1150 thresholds.

With a Bank of England hike in the offing for next week’s meeting, the pound is holding its ground around the 1.2800 level, but continues to fail in building momentum for a breakout to the topside. Markets think the central bank will deliver a quarter-point move, but with wage gains raising the likelihood that inflation remains persistent, a larger, half-point move remains possible – although that would also raise the risk of a hard landing, and might follow recent precedent in having a relatively modest impact on gilt yields and the pound.

Asia Pacific

In a surprise decision – albeit one leaked earlier in the North American session by the Nikkei news agency – the Bank of Japan last night said it would allow yields to move “more flexibly,” meaning that it would allow ten-year interest rates to rise to 1 percent, doubling the previous 0.5-percent ceiling. The central bank kept its main benchmark interest rate unchanged and upgraded its inflation forecasts, with core price growth seen topping 2.5 percent in 2023, 1.9 percent next year, and 1.6 percent in 2025. The yen ultimately climbed more than 1 percent in volatile trading conditions, but failed to post more material gains as global yields mirrored the move in Japanese government bonds, climbing on the prospect of reduced Japanese buying.

Some yen-funded carry traders got caught picking up nickels in front of steamrollers when the decision triggered a jump in borrowing costs, but on a year-to-date basis, realized returns remain incredibly high. The trade – which involves borrowing in a low-yielding currency, parking the funds in a high-yielding currency, and pocketing the difference, or “carry” – still looks remarkably attractive, given the wide rate differentials on offer across the foreign exchange landscape, and the impact on global markets could be profound if it grows to scale again, with global liquidity expanding and contracting more violently in response to changes in background volatility as speculators manage their positions – meaning that currencies could soon slide back into the “risk on, risk off” trading dynamics that triggered so much turbulence in recent decades.

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