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Yuan plummets, dollar pushes toward eighth weekly gain

Faith in a US soft landing – bolstered by yesterday’s surprise drop in initial jobless claims – seems to be on shakier ground this morning. Equity futures are broadly lower, Treasury yields are slipping, and the dollar is down almost imperceptibly – although it remains on course toward closing out an eighth week of gains against its major counterparts.

The Canadian dollar is essentially unchanged after Governor Tiff Macklem hinted that the Bank of Canada’s monetary tightening cycle was drawing to a close. “With past interest rate increases still working their way through the economy,” he said “monetary policy may be sufficiently restrictive to restore price stability”. Most market participants, including ourselves, think July’s hike will ultimately prove to have marked the peak in Canadian rates, and are now moving to price the first cuts by mid-2024.

The country’s August employment numbers, due in half an hour, are expected to show a modest recovery in job creation, with around 15,000 positions added. The unemployment rate, partly driven by population growth, is seen pushing higher to 5.6 percent, while year-over-year wage growth slips to 4.7 percent from the prior 5 percent – numbers that, taken collectively, should ratify expectations for a prolonged plateau in Canadian rates.

The Chinese yuan was the only big mover on the currency charts overnight, with the offshore liquidity pool trading down to the lowest levels on record as authorities guided the currency through a controlled depreciation. The dollar exchange rate fell through the closely-watched 7.35 level as inward capital flows slowed to a trickle and the state-managed banking system mounted a half-hearted defence effort.

More broadly, we’re increasingly convinced that markets have over-egged the “Chinese decline” narrative. There’s little doubt that the country’s economic model is reaching its limits and that the long-term growth trajectory is unlikely to live up to previously-naive Western extrapolations. But China’s growth rates are still well above their developed-market equivalents, the government has vast resources available to help sustain activity levels, and relatively easy (albeit politically-unpalatable) policy choices could help the middle class emerge as a stabilizing force in the economy over the long run. With markets currently more bearish than we can remember, a reversal in sentiment looks increasingly likely.

Next week will bring a European Central Bank rate decision and the latest US consumer price numbers. Markets have long assumed that the euro area would see another rate increase in the autumn months, implying that any move on the spectrum between a “hawkish hold” and an outright hike should leave interest differentials largely intact. But we think the US data could have wider implications, with a higher-than-consensus print making a final Federal Reserve rate hike more likely, in contrast with a softer than anticipated number – which (coming after a raft of remarkably strong data releases in recent weeks) might trigger a downward shift in the implied policy trajectory and weaken overall dollar valuations.

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Higher for (even) longer