The Canadian dollar joined the Japanese yen and the Kiwi dollar in retracing Friday’s losses. While its peers still sit in the red over the course of the two trading sessions, the loonie managed to tip its nose into the green, with yesterday’s rally extended by a strong session for US equities, a 2% rally in crude despite the continued downturn in manufacturing activity, and a rally in front-end Canadian bond yields following more inflationary data out of the US. Today, cross-asset signals are likely to remain in the driving seat for USDCAD, with nothing due out domestically ahead of tomorrow’s publication of the BoC’s latest meeting minutes.
It has been all about growth conditions at the start of this week, with flash PMIs yesterday providing the differentiator in global markets and this morning’s mild risk-on bid supported by Beijing officials signalling further support for the ailing housing market and the consumer. Starting with yesterday’s data, PMIs across Europe and the US signalled a broad slowdown in global growth. The well-known recession in global manufacturing continued either side of the Atlantic, however this was now joined by a slowdown in services activity. Most importantly for markets was the fact that the slowdown in services activity was so significant in parts of Europe that it pointed towards outright recessions in GDP, a dynamic that would compress corporate profit margins and help bring down inflation. Whereas the slowdown in services growth in the US was far less extreme, leading the composite PMI to signal an annualised quarterly growth rate of around 1.5% at the start of Q3. The stark contrast in growth rates led US equities to outperform European bourses on the day. Meanwhile in the fixed income space, it was all about what these growth rates meant for central bank policy. While the European data confirmed our long held view that the ECB would struggle taking its deposit rate to 4% in September and further confirmed the case for a deceleration in the BoE’s hiking cycle next week, the resiliency in the US consumer actually led US services providers to increase pace of price increases well above the long-run series average, suggesting that US CPI may be stuck around the 3% mark for longer than markets anticipated. The threat of inflation persistence from a better growth outlook naturally reignited expectations of a Q4 rate hike from the Fed, leading front-end Treasury yields higher. The relative outperformance of US yields and equities yesterday fuelled the dollar’s rally, even as the headline PMIs undershot expectations. However, the strength in the greenback wasn’t broad based, as currencies that excessively underperformed on Friday benefitted from a broad retracement.
The dislocated returns within G10 FX against the dollar aren’t present this morning, however. The dollar DXY index is down a tenth of a percent, with the whole G10 currency board flashing green. The catalyst behind the move is further announced support for the housing sector and the Chinese consumer from policymakers in Beijing after the July Politburo meeting. While the details of any support measures are likely, the announcement of more countercyclical measures nonetheless and the continued confidence by officials that the 5% growth target can be achieved has led to a strong rally in Chinese equities overnight and a better supported risk backdrop globally. Today, the data calendar briefly thins out. In the US, only secondary releases in the form of the CoreLogic house price index and consumer and business sentiment indices are set to be published.
The single currency traded on the back foot for the entirety of yesterday’s session following the publication of France’s preliminary PMIs for July. Signalling that the downturn in growth conditions in June wasn’t an isolated instance driven by increased industrial activity, the French growth indices set the scene for what was a bleak day for European growth conditions. Germany’s data, released shortly afterwards, continued the negative theme as the manufacturing index fell to its lowest level since May 2020, while the services PMI also undershot expectations by a considerable margin albeit to print still in expansionary territory. Nonetheless, the German composite PMI slipped below the no-change 50 level for the first time since January, a sign that the eurozone growth engine is once again sputtering after recording a technical recession over the winter months. The weaker growth outlook wasn’t just reflected in the half a percent drop in EURUSD, but also in short-term interest rate markets. Here, pricing of a second consecutive hike in September fell to 50%, however the largest repricing took place at the year-end rate, which was revised down to just 3.85%. Today, the prospect of continued tightening from the ECB remains in focus as the results of the Q2 bank lending survey are released at 09:00 BST. Should the data show credit conditions tighten significantly more than banks had originally estimated towards the end of Q1, the case for an earlier pause in the hiking cycle will once again become more compelling. In our view, the dovish repricing of the ECB’s policy path will be one of the main themes this week, especially if the ECB remains non-committal to its next steps and inflation data on Friday meets expectations and shows renewed disinflation. If we are correct, we expect to see EURUSD trading back below 1.10 by the weekend.
While sterling also corrected lower yesterday on the back of softer PMIs and a dovish repricing in interest rate expectations, its drop was dwarfed by that of the euro as ultimately data showing a stagflationary economic backdrop isn’t news anymore. With no more major data releases set to take place ahead of next week’s BoE meeting, the softer PMIs and more specifically the cooling price sub-indices led pricing for the Bank’s next steps to flip in favour of our base case. That is, a return to 25bp increases as upstream indicators suggest more disinflation is in the pipeline. As mentioned, the data calendar is now incredibly light ahead of next Thursday’s interest rate decision, with just the Confederation of British Industry’s measure of business optimism and total orders set to be released at 11:00 BST.