Written by Convera’s Market Insights team
CPI likely won’t rescue the dollar this week
Boris Kovacevic – Global Macro Strategist
Last week’s dovish but ambiguous labor market data wasn’t enough for the Fed to commit to a jumbo rate cut. It is now up to the inflation report to change that. However, despite the clear negative trend of economic momentum, the bar for a 50-basis point cut seems high. The reasoning has more to do with timing than anything else. We have entered the Fed’s blackout period and the only two comments we have from after the labor market report came from Governor Waller and NY Fed President Williams.
Both weren’t convincingly arguing for a definite large rate cut at the upcoming meeting and with nothing else to go by, only another spike in market volatility could derail a small cut from happening. That explains the pullback in easing bets following the Waller speech as market pricing for a 50-basis point cut (our initial call) fell from 75% to 30%.
Despite that, global equity markets started the week on stronger footing as dip buying behavior persisted. In a sense, investors are still hoping for central banks to save the day before the growth scares forms a life of its own. The Bank of Canada cut its benchmark policy for a third time this year last week as the European Central Bank prepares for its second cut on Thursday.
The US dollar followed bond yields higher ahead of the presidential debates tonight and crucial CPI report on Wednesday. The Greenback has recently been on a downward spiral, losing about 4% since the beginning of July, and falling into negative territory on the year overall. The gravitational pull from falling bond yields and elevated Fed easing bets have dented the appeal for the US currency. The medium-term negative bias remains. In the near term, more disappointing below-consensus macro data is needed to drag pairs like EUR/USD and GBP/USD higher. Inflation likely won’t help the dollar this week as its expected to fall from 2.9% to 2.6% in August. Given the baseline of a 25 basis point cut, a downside surprise on inflation would have more of an impact on markets than an equal upside beat.
Markets underpricing risks ahead?
Boris Kovacevic – Global Macro Strategist
The British pound is slowly inching away from its 5-month high ($1.3270) reached against the dollar at the end of August. Global sentiment is rebounding after Friday’s weaker than expected US job report send shockwaves through financial markets. Sterling has not caught a bid so far this week, though. Investors are awaiting crucial data before the Fed and BoE decisions later this month and are cautious about chasing the pound beyond the $1.31 level at the moment.
Today’s employment numbers from the United Kingdom came in close to expectation, leaving little room for significant repricing. Unemployment fell by 73.6k to 4.1% in the three months to July. Average earnings growth slowed a bit more than expected from 4.6% to 4.0% as earnings ex-bonuses decelerated from 5.4% to 5.1%. The totality of the data doesn’t seem to justify policy easing from the Bank of England in September with the implied probability of a rate cut standing at around 22%. Markets currently price in only one rate cut from the central bank, which we perceive as too hawkish. Falling inflation and wage growth going into year-end could make another rate cut possible.
With the labor market reports from the US and UK out of the way, investors will now quickly shift attention to the GDP and inflation reports. Tomorrow morning will see GDP, goods trade, industrial production, and manufacturing production being published for the UK, while US inflation figured later that day will likely decide if the Federal Reserve eases policy by 25 or 50 basis points next week. 1-week implied volatility rates for GBP/USD and GBP/EUR have recently fallen to their 2024 averages at around 6.4% and 4.4%. With global equities heading into a seasonally weak period of the year and the rate decisions and US election coming up, investors could be underpricing the underlying risks in FX markets.
Calling the China bottom has been a lost cause
Boris Kovacevic – Global Macro Strategist
Most analysts covering Chinese macro and monetary policy have been puzzled by the lack of stimulus introduced this year. The negative sentiment was once again fueled by disappointing inflation figures starting off the week. Consumer inflation rose by 0.6% compared to last year. Growth accelerated from the previous month (0.5%) but came in below expectation (0.7%). The Chinese benchmark CSI 300 is on track to fall for a fourth consecutive week and reached the lowest level since February on Monday. USD/CNY rebounded from a 14-month low of 7.080, after having fallen by about 2.5% since July.
We have recently argued that both fiscal and monetary policy just don’t have the firepower they once had. (1) Financial conditions are the most accommodative since records began. (2) Bond yields are the lowest on record. (3) Official lending rates are at record lows. (4) The reserve requirement ratio is the lowest since 2007. (5) The Chinese private debt-to-GDP ratio is approaching levels seen during the peak of the Japanese bubble in the 90s. (6) And finally, the budget deficit averaged just shy of 7% in the years following the pandemic.
So, policy is supportive by any stretch of the imagination, just not enough to bring back growth to levels we are used to from China. Policy makers know this and are sacrificing easy short-term stimulus-driven gains for the possibility of a sustainable growth path in the future. This strategy is still to bear fruits as the rotation from manufacturing to domestic consumption stalled post-covid. This divergence can be seen in today’s trade figures. Exports reached a 17-month high, rising by 8.7% on an annual basis, while import growth slowed from 7.2% in July to just 0.5% in August.
Euro nears a 1-week low
European equities opened higher on Monday, gaining nearly 1%, as dip-buying interest emerged following the post-NFPs selloff. However, with the Stoxx50 month-to-date losses exceeding 3.5%, equities have significant ground to recover, especially in a seasonally unfavourable period. Bonds reversed early session losses and ended the day marginally higher, outperforming US Treasuries. Consequently, the 2-year Germany-US yield spread widened by 3bps but remains near May 2023 levels. In the FX market, the euro had a weak start to the week, dropping almost 0.4% on Monday amid renewed dollar strength, as the market scaled back some of its jumbo bets on a substantial Fed rate cut next week.
On the macro front, the first round of this month’s business surveys continues to reflect a familiar pattern observed over the past two months. After peaking in June, business sentiment continues to decline. The September Sentix index fell to -15.4, down from -13.9 in August, missing consensus expectations for a marginal rebound. The assessment of the current situation dropped to levels last seen in January, while the expectations index, which gauges economic sentiment six months ahead, ticked slightly higher but remains near its 2024 lows. Euro bulls, hoping for another retest of the $1.12 level, are still waiting, as Eurozone fundamentals increasingly act as a headwind for further gains.
Looking ahead, EUR/USD is supported near the $1.104 level, but this support could be tested soon. With limited domestic macro events ahead of Thursday’s ECB rate decision, the US election debate later tonight may serve as the first major catalyst this week. The one-week risk reversals narrowed sharply during yesterday’s session but remain marginally skewed in favour of euro calls.
Dollar catching a bid this week
Table: 7-day currency trends and trading ranges
Key global risk events
Calendar: September 9-13
All times are in BST
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*The FX rates published are provided by Convera’s Market Insights team for research purposes only. The rates have a unique source and may not align to any live exchange rates quoted on other sites. They are not an indication of actual buy/sell rates, or a financial offer.
