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Surging Dollar Squeezes Global Markets

Treasury yields are holding yesterday’s gains and the dollar is steamrolling its way past an eight-month high this morning as global borrowing costs rise and threaten economies outside the US.

This morning’s jobless claims data could deliver further evidence of a cooling in US labour markets. Initial claims have remained low in recent months, but the number of people on longer-term benefits is clearly creeping higher, aligning with a generalised rise in the unemployment rate. According to recent data releases, job openings are now below long-term trends, hiring rates are coming down, the vacancy-to-unemployed worker ratio is back to 2019 levels, and the quits rate has declined as job-holders have grown less confident on their prospects.

Against this backdrop, it is somewhat surprising to see markets internalising messaging from the Fed’s most overtly-hawkish member. Governor Michelle Bowman yesterday reiterated her concerns about making “modest further progress on inflation,” saying “We are still not yet at the point where it is appropriate to lower the policy rate, and I continue to see a number of upside risks to inflation … I remain willing to raise the target range for the federal funds rate at a future meeting should the incoming data indicate that progress on inflation has stalled or reversed”.

We suspect Bowman’s comments would be given short shrift if Canada and Australia hadn’t delivered disconcertingly-strong inflation numbers earlier in the week. It’s unlikely to last, but with the two small, open economies playing a “canary in a coal mine” role in global markets, investors have moved to hedge against a potential “higher forever” stance from the major central banks, and hawkish views are gaining greater credence.

The Japanese yen is up slightly, responding favourably to jawboning efforts from government officials. Speaking with reporters last night, Finance Minister Shunichi Suzuki expressed concern about the impact the weak yen could have on the economy, saying “one-sided moves in the foreign exchange market are not desirable as currencies should reflect fundamentals and move in a stable manner,” phrasing that has historically signalled increased intervention risk. Realised volatility remains relatively low, and we suspect authorities are not quite ready to step in – but the exchange rate is down almost 12 percent on a year to date basis, and the selloff could accelerate after tomorrow’s US personal consumption expenditures print, with a sudden move to 162 or beyond acting as a potential tripwire for central bank action.

Mexico’s peso is looking bruised and battered ahead of this afternoon’s Banxico decision, raising the potential for upside gains. Policymakers are widely expected to maintain a dovish bias while keeping rates unchanged, but the currency’s recent depreciation – coupled with hotter-than-expected inflation data from earlier in the week – could translate into a more hawkish set of communications. Mexico’s mid-month consumer price index showed headline inflation rising 4.78 percent year-over-year in early June, while core prices gained 4.17 percent, slowing more gradually than had been anticipated, and remaining stubbornly above the central bank’s target range. Markets are pricing in roughly 75 basis points in rate cuts over the coming 12 months, down from 125 in early May, and we think there’s room for further adjustment if officials turn incrementally less accommodative.

The Canadian dollar remains on the defensive as markets ignore a fall in domestic rate cut odds in favour of trading the greenback’s momentum. Tomorrow morning will almost certainly bring more of the same – the US personal income and spending report is likely to drive price action more than Canada’s gross domestic product numbers – but the early estimate for May’s output growth could nonetheless help calibrate longer-term policy expectations. Consensus estimates currently suggest that the Canadian economy will expand 0.9 percent this year, well below the 2.3 percent expected south of the border, but we think this gap could narrow in the coming months as the US shows clearer signs of strain.

Tonight’s US presidential debate could see the candidates engaging in a substantive discussion on the economy, government debt, and international trade. But we doubt it. In a strange historical twist, today’s Democrats and Republicans are relatively tightly aligned on the need for a more interventionist government, higher spending, and more protectionist trade policy, with differences mostly coming down to tactics and specific priorities – both Trump and Biden managed to widen US budget and trade deficits while in office, before and after the pandemic. Instead, the debate’s market implications are likely to hinge on whether the current president can cut into the former president’s lead in election odds, with trade-sensitive currencies in the firing line if a more isolationist Trump pulls further ahead.

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