In a risk-off day for markets, the loonie traded poorly against the dollar, but in the middle of the pack compared to its G10 peers. Much of the weak sentiment had to do with a re-steepening in the US yield curve, which equity analysts say is a poor omen for stocks when the curve has been deeply negative. With bearish sentiment picking up in virtually every global market, and Canadian yields that couldn’t keep pace with the US, yesterday was not a favourable one for CAD. That said, news flow and data were relatively light, and especially without much of a fundamental reason for a move, markets can be fickle. Today’s calendar will also be light, and the price action will probably reflect positioning ahead of Friday’s jobs reports. Economists anticipate a substantial slowdown in the pace of hiring, pencilling a 15.7k increase in jobs for Canada in July, down from 59.9k in June.
Traders screens were once again covered in a sea of red yesterday as de-risking was once again the dominating theme across markets. As we noted yesterday, this dynamic may be taking place at the start of August as investors square some positions on the soft landing trade that had served them so well throughout July ahead of key data that will assess the health of the US consumer today and tomorrow, but the lingering possibility of a Q4 rate hike and a higher neutral rate of interest in the US is also playing a role on dragging equities lower and the dollar higher. Two-year inflation adjusted yields are trading at their highest level since the peak of the global financial crisis at 3.05%, while both nominal and inflation adjusted longer-dated Treasury yields are at the peaks last seen in Autumn 2022 during the peak pace of the Fed’s tightening cycle and when the S&P 500 was officially in a bear market on mounting recession fears.
Whether the positive relationship between Treasury yields and equities can return to the levels seen over recent weeks largely depends on key earnings figures from Amazon and Apple today, the strength of the ISM services PMI this afternoon at 15:00 BST, and whether the US labour market continues to promote job security and produce strong levels of wage growth. In the interim, markets are a bit more wary of this outcome, even after yesterday’s ADP measure of employment printed substantially above estimates at 324k, although this holds less gravitas after last month’s ADP measure produced a forecast error of +246k on the official payrolls print.
Nonetheless, price action over the past few days highlights the limitations of taking the dollar lower, even on the soft landing narrative, underscoring our view that the greenback is going to remain well supported until the advanced progress of US disinflation leads markets to price in near-term rate cuts from the Fed earlier than the its peers. Currently a full rate cut from the Fed isn’t priced until May 2024. On the topic of rate cuts in the Americas, the Central Bank of Brazil (BCB) cut rates by 50bps late last night to 13.25%, more than we and the economist consensus had expected and in line with the magnitude that may concern foreign investors given it falls in line with the government’s long-standing preference of faster easing. However, the bearish impact of yesterday’s decision is likely to be offset by more dovish connotations accompanying the move when onshore markets open this afternoon. Not only was the vote split tight at 5-4 in favour of a 50-25bp cut, but the BCB’s inflation forecasts were only slightly above target in 2024 and 2025 under the consensus forecasts for the Selic rate of 12% at year-end and 9.25% at the end of 2024. Whether this works in offsetting concerns over government interference in the BCB’s decision-making will be seen when local markets open at 13:00 BST.
The single currency wasn’t exempt from the risk-off session yesterday, although its half a percent decline towards our one-month forecast meant it was one of the more defensive G10 currencies against the dollar rally. While global equities largely did the damage in terms of risk sentiment, arguably it was the rise in Treasury yields that weighed on the rate sensitive single currency, especially as markets remain sceptical that the ECB can hike further on the currently soft growth conditions. Those concerns won’t be allayed with the release of Spain’s PMIs this morning. The composite measure fell from 52.6 to 51.7, driven by a tumbling in the services PMI from 53.4 to 52.8. With only the Italian measure set to be released alongside Italian retail sales for the remainder of the day, undoubtedly it will be events the other sides of the Channel and the Atlantic that will determine the single currency’s fortunes today. In other news, inflation data out of Switzerland met expectations with a reading of -0.1% MoM, bringing the headline measure 0.1pp lower to 1.6%. More importantly, however, is that core inflation marginally undershot expectations with a reading of 1.7%, suggesting the SNB may be able to end its hiking cycle here. While in theory this should weigh on CHF, we note that EURCHF has been disconnected from rate differentials for some time. With the SNB active in defending any substantial bouts of EURCHF appreciation and growth conditions on the continent tentative, we think the more muted reaction in the cross is warranted.
While the US cross-over and the release of the ADP measure of private employment in the States had an impact in levelling earlier gains in cable yesterday, it was the release of the Citi/YouGov measure of inflation expectations that drove sterling lower on the day. Both the 5-10 year and 1-year ahead measures fell, with the former falling from 3.3% to 3.2% and the latter from 5% to 4.3% respectively. The data added to a growing accumulation of evidence that should give the BoE reason to slow the pace of its hiking cycle with a 25bps hike this afternoon, however, we note that there is still a risk that policymakers don’t find comfort in the still-elevated level of services inflation and wage growth, forcing another 50bp increase. Under our base case of a 25bp hike in Bank Rate to 5.25%, we think sterling has further to fall, especially if the decision is accompanied by more neutral guidance in the Monetary Policy Report and from Governor Bailey in the press conference. Naturally, more hawkish guidance that confirms the market pricing of two further hikes would mitigate the impact of a 25bp hike, while we view a 50bp increase as net positive for sterling despite the impact it will have on raising financial stability fears given the currency’s sensitivity to rate differentials. All told, while we have confidence that the BoE will meet our base case, the risks of a more hawkish surprise are sizable.