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US Slowdown Concerns Weigh on Risk Appetite

The dollar is steadying, Treasury yields are moving sideways, and equity futures are down after Monday’s session brought new evidence of the growing headwinds facing the US economy – raising hopes for earlier policy easing from the Federal Reserve while also challenging earnings expectations.

Yesterday’s Institute for Supply Management manufacturing survey proved disappointing. The factory sector remained in negative territory, with the headline index unexpectedly declining to 48.7, down from 49.2 in the prior month, and well below the 50 threshold that separates expansion from contraction. Most worrisomely, the new orders sub-index fell below inventories, suggesting that businesses could slow the restocking process.

Further confirmation of a coming consumer slowdown could be provided later this morning when data from the latest Job Openings and Labor Turnover Survey are released. Economists think the number of positions available dropped to roughly 8.3 million from 8.49 in the prior month, bringing the vacancy-to-unemployment ratio to within striking distance of pre-pandemic peaks. Although lags can be long and variable, softer labour market demand typically translates into weaker wage growth and a decline in consumer spending.

But the jury is still out. Although the manufacturing sector maintains a stranglehold on the popular imagination, it is the services sector that drives the bulk of US economic activity. Tomorrow’s services survey from Institute for Supply Management, and Friday’s non-farm payrolls report should give us a far more accurate understanding of underlying conditions.

Mexico’s peso is still sinking as investors grow increasingly uncomfortable with a realigned political landscape. Final results are still coming in, but it looks as if the governing coalition led by new president Claudia Sheinbaum has captured a two-thirds majority in the lower chamber of Congress and will narrowly miss achieving a so-called “supermajority” in the Senate. This means that only a few swing votes will be needed to pass changes to the constitution and follow through on the government’s long-held desire to remove checks and balances, and assert greater state control over the economy. The dollar-peso exchange rate is now down -6 percent relative to Friday’s close, and implied volatility remains extremely elevated.

We nonetheless suspect modest gains are in the offing in the days ahead as the shock wears off and the peso’s still-attractive volatility-adjusted carry profile brings in buyers. Although the new president will clearly seek to establish policy continuity with the outgoing Andrés Manuel López Obrador administration, there are signs of a return to a more disciplined approach in the months ahead as the election is put in the rear-view mirror: as Sheinbaum put it shortly after achieving victory, she plans to maintain “austerity, financial and fiscal discipline and autonomy,” ensuring that Mexico “will never have an authoritarian or oppressive government”. “We will maintain the required division between the economic power and the political power,” she said – “We will always defend and we will work for the ultimate interest of the people of Mexico and of the nation”.

The Canadian dollar is well-ensconced near the bottom of its trading range as traders ride market momentum into tomorrow’s Bank of Canada announcement. Markets are well prepared for a rate cut at one of the Bank’s next two meetings, and longer-term expectations for moves are the lowest among advanced economies. With Canada’s long over-dependence on debt-fuelled growth leaving the household sector incredibly vulnerable to higher borrowing costs, policymakers are seen easing rates eight times over the next three years – outpacing the US, and coming from a lower starting point. This outlook is likely to keep short interest in the currency elevated for now, but we would warn that market participants would do well to watch developments in the US fairly closely – the greenback looks priced for perfection, and a summer correction is possible if the American economy shows signs of converging with Canada’s.

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