The volatility shock caused by the unwinding of popular positions came and went. Global equities have risen for a second consecutive week with the Nasdaq’s and Topix’s 12% and 22% rise from last Monday’s low leading the rotation into risk assets.
Global markets welcomed news about US inflation easing for a fourth consecutive month and falling to the lowest level since early 2021. Headline inflation surprised the consensus to the downside, coming in at 2.9% on an annual basis in July.
Stronger retail sales and lower jobless claims numbers signaled that the US soft landing is still intact, a positive catalyst for equities and broader investor sentiment. The Fed is now more likely to deliver a 25-basis point cut in September.
Britain’s economy created more jobs than expected, delivering a surprise drop in the unemployment rate from 4.4% to 4.2% and below the consensus forecast of 4.5%. Wages rose at the slowest pace in almost two years, cooling from 5.8% to 5.4%.
Germany is facing the prospect of minimal economic expansion this year, which is weighing down Eurozone economic momentum. Germany’s ZEW Economic Sentiment report for August plummeted to its lowest level since January.
Week ahead. Central bankers will take the Jackson Hole Symposium as an opportunity to fine tune the communication regarding their monetary policy.
The euro is benefiting from a renewed risk-on sentiment, despite investors adjusting their expectations for significant Fed easing in 2024.
Regional outlook: United States
US recession risks ease, for now
Investors taking risks again. FX markets have experienced a turbulent summer due to increasing concerns about a more pronounced US economic slowdown and questions are being raised about whether the Federal Reserve (Fed) has maintained high interest rates for too long. However, volatility indices are mean reverting, bolstered by a series of positive US macro releases easing recession fears. Risk appetite has firmed this week, supporting pro-cyclical currencies and halting safe haven demand. Global equities have risen for a second consecutive week as bond yield tread water and the US dollar continues its four-week downtrend.
Disinflation confirms Fed easing. Global markets welcomed news about US inflation easing for a fourth consecutive month and falling to the lowest level since early 2021. Headline inflation surprised the consensus to the downside, coming in at 2.9% on an annual and 1.6% on a 3-month annualized basis in July. While the details of the CPI and PPI readings that flow into the Fed’s preferred inflation gauge (PCE) coming up later this month could see the index move higher, it is unlikely to deter the expected beginning of the easing cycle. Broadly speaking, price pressures are continuing to slow and will give the Federal Reserve (Fed) more confidence to ease policy over the coming meetings. The question has changed from asking if the Fed will cut in September to how much easing is feasible.
25bp vs. 50bp? Stronger retail sales and jobless claims numbers signaled that the US soft landing is still intact, a positive catalyst for equities and broader investor sentiment. Following the two data prints, the current dynamic means the Fed is more likely to deliver a 25-basis point cut as opposed to 50-basis-point cut when it begins easing, likely in September. And while the prospect of fewer rate reductions had in the past weighed on stocks, this time it’s being driven by the notion that recession risks may be overstated. This assumption will be in place until proven otherwise by the data.
Regional outlook: United Kingdom
Robust economy, slowing inflation
Strong UK spending. On the macro front, the July retail sales rose 0.5% month-over-month, in line with market expectations. Sales at non-food stores increased by 1.4%, particularly in department stores and sports equipment stores, attributed to summer discounting and sporting events. Excluding fuel, retail sales rose 0.7%, which was stronger than the 0.6% rate economists had expected. The proportion of sales made online also edged up to 27.8% from 27.4% the month before.
Tight labor market. Britain’s economy created more jobs than expected in the three months to June, delivering a surprise drop in the unemployment rate from 4.4% to 4.2% and well below the consensus forecast of 4.5%. That said, wages rose at the slowest pace in almost two years, cooling from 5.8% to 5.4%, the latest sign of a cooling labour market. While the jobs figures have been distorted by problems with the labour market survey, the news on wages was very much in line with what officials would want to see, though rate expectations remain unmoved.
Still, cuts are coming. A smaller-than-expected rise in UK inflation in July has traders confident that more Bank of England (BoE) cuts are coming. Markets are almost fully pricing in two more 25-basis point rate reductions this year compared to 44 basis points before the inflation report. UK CPI advanced 2.2% in July and is expected to creep higher still because the impact of lower household energy prices is dropping out of the annual comparison. However, this comes as no surprise and was forecast by the BoE. Instead, more attention is on services inflation to guide policy and that posted its lowest reading in more than two years, sitting at 5.2% down from 5.7% in June and crucially, well below the BoE’s 5.6% forecast. Survey data also show firms are raising prices much less aggressively than they were and with wage growth also cooling, these conditions should help unlock at least one rate cut, possibly two more before year-end.
Regional outlook: Eurozone
Dismissive of slowing momentum
Growth propped up by services, manufacturing disappoints. The second estimate of Eurozone Q2 GDP growth came in line with expectations, but employment growth was weaker than anticipated, signalling potential trouble ahead. Additionally, June industrial production fell by 3.9% year-on-year, exceeding expectations of a 2.9% decline. In fact, Eurozone industrial production has contracted every single month in 2024 on a year-on-year basis. With the manufacturing sector remaining weak and showing little sign of recovery, it is likely to weigh on growth in Q3 2024. Consequently, Eurozone growth is likely to depend more on the services sector for now.
Leading indicators signal trouble ahead. Germany’s ZEW Economic Sentiment report for August plummeted to its lowest level since January, extending a disappointing run of domestic data and recent turmoil in global stock markets. The expectations gauge fell sharply to 19.2 from 41.8 in July, significantly below the market consensus of 34. An index of current conditions also declined more than expected. Economic expectations are likely still being influenced by high levels of uncertainty, driven by ambiguous monetary policy, disappointing business data from the U.S. economy, and growing concerns over an escalation of conflict in the Middle East.
Are investors immune to EZ growth risks, or are risks fairly priced? Germany is facing the prospect of minimal economic expansion this year, which is weighing down Eurozone economic momentum. Despite this, markets have yet again shrugged off the stark warning. ECB rate-cut wagers remain broadly steady, with pricing indicating a 25 basis points easing in September and 70 basis points by year-end. Instead, investors continue to focus almost exclusively on US-centric developments.
Week ahead
Central bank gathering in Jackson Hole
The backdrop. The global volatility shock caused by the unwinding of popular positions like shorting the yen came and went. Global equities have risen for a second consecutive week with the Nasdaq’s and Topix’s 12% and 22% rise from last Monday’s low leading the capital rotation into risk assets. The Greenback is on the defense despite falling US recession risks due to inflation continuing to cool and the Fed expected to start the easing cycle in September. Central bankers will take the Jackson Hole Symposium as an opportunity to fine tune the communication regarding their monetary policy.
Jackson Hole Symposium. The important central bank gathering in Jackson hole takes place against the backdrop of a lot of macro uncertainty and at a crucial turning point for policy makers. The global soft-landing scenario is still intact, but pockets of weakness are starting to form, which is why around 175 basis points of Fed cuts are being priced over the next 12 months. All eyes will be on FOMC Chair Jerome Powell as he speaks under the umbrella of this years Jackson Hole subject: Reassessing the Effectiveness and Transmission of Monetary Policy.
Central banks. Staying on the topic of central banks, the minutes from the last ECB meeting could give some indication on whetever another rate cut in September come to fruition. In Sweden, the broad-based expectation is for the Riksbank to cut interest rates by 20 basis points on Tuesday die to inflation risks being tilted to the downside. This is not the case for the Peoples Bank of China, where policy is expected to remain unchanged at 3.35%. Policy easing will likely have to wait until the Fed has started cutting interest rates. Japan will stay in focus as well. Should core inflation rise by 0.1% to 2.7% in July as expected, this would reignite calls for further policy tightening by the Bank of Japan.
FX Views
Disinflation pressuring the dollar
USD Bearish tilt after benign inflation. We have leant bearish on the US dollar of late given the stabilisation in global risk sentiment and recalibration of US interest rate expectations to the dovish side. Weakening rate differentials have weighed on the buck recently, with the dollar index primed for four weekly losses on the bounce and trading 1.5% below its 2-year average. Benign US inflation prints of late have cleared the path for more risk-on/dollar-off trading, but we’re conscious that a US or global economic slowdown phase presents a complex scenario for global FX markets. A slowing economy from above-trend output typically pressures the US dollar, but a slowdown leading to a clearly negative output gap tends to support the dollar due to its safe-haven status. For now, due to its weakening growth and yield appeal, this transition phase for the dollar introduces near-term downside risks for the US currency. But it does not necessarily overturn the current strong dollar regime, especially while structural factors such as protectionism/tariff risks and increased US fiscal stimulus, continue to play a supporting role. The Jackson Hole Economic Policy Symposium next week will provide more clues on the economic and monetary outlook, to further steer market trends.
EUR Supported by risk-on sentiment. The euro is benefiting from a renewed risk-on sentiment, despite investors adjusting their expectations for significant Fed easing in 2024. Positive US economic data eased concerns about a rapidly worsening US outlook, which led to a minor widening of the front-end US-DE spread, temporarily pushing EUR/USD to $1.095. The currency pair remains largely driven by US macro and Fed expectations, with investors largely immune to growing risks to the Eurozone economy. Market stability has improved, and the one-week EUR/USD implied volatility has dropped to a three-week low, reflecting reduced anxiety. Next week’s negotiated wages data could shift focus to the ECB, as the metric is critical for the Governing Council when considering future rate cuts. Recent data from Italy has shown persistent upward wage pressures, and if this trend is echoed in the broader Eurozone figures, it could challenge expectations of an ECB rate cut in September, potentially boosting the euro.
GBP Balanced versus euro; upside potential versus dollar. Rate differentials had indicated that sterling was overvalued against the euro, hence GBP/EUR’s adjustment to a more balanced level around €1.16-€1.17 from over 2-year highs above €1.19. The correction lower has seen the pair fall for five weeks, its worst stretch since Q3 2022. Further fuelling the decline was the softer-than-expected UK services inflation print, boosting BoE easing bets and dragging the UK-German 2-year yield spread to its lowest in over a year. The 200-week moving average looks like a strong support at €1.1609 though, whilst the 200-day MA is proving a tough short-term resistance barrier at €1.1692. Despite sterling’s struggles in August, the 1-year UK-US rate differential suggests GBP/USD’s circa 3% drop since mid-July may have been overdone though. Indeed, downward momentum slowed near the 100- and 200-day MAs, allowing cable to snap a 4-week losing streak and rebound over 1.5% from last week’s lows, back above its 5-year average of $1.28. The pair is flirting with the 200-week MA resistance obstacle, but a convincing close above it could support further gains in the short-term. Stable equity markets and a sustained global easing bias should remain supportive for the pro-cyclical currency, particularly against its safe haven peers. But sterling needs a new positive catalyst to strengthen its upward trajectory from the first half of 2024.
CHF Pares gains in calmer markets. The franc had surged almost 5% against the US dollar and more than 3% against the euro in the three months through July. The trade-weighted franc adjusted for inflation had therefore risen to such elevated levels that perhaps made the Swiss National Bank wary of the currency’s inordinate appreciation. Unlike most of its peers, the SNB has long been quite active in the currency markets given that foreign trade accounts for a large part of Switzerland’s GDP, and exports constitute the small economy’s main engine. It is likely that the SNB’s balance sheet has grown in recent days as the central bank acted to check the franc’s strength. Indeed, both EUR/CHF and USD/CHF have both rebounded over 3% from last week’s lows, helped by improving global risk sentiment and calmer market conditions. Looking ahead though, given speculators are still net short the franc, if there is further carry-trade unwinding on the horizon, the low-yielding Swiss currency could be a key beneficiary second to the Japanese yen.
CNY Property woes and policy constraints weigh on sentiment. According to Reuters estimates using data from the National Bureau of Statistics (NBS), China’s new house prices dropped 4.9% y/y in July, marking the sharpest decline in nine years. In June, prices had dropped 4.5%. For the thirteenth consecutive month, new house prices fell on a monthly basis, down at the same rate of 0.7% as in June. According to the statistics, market stabilization and the restoration of trust in Chinese real estate are still awaiting the implementation of supporting measures. Separately, PBoC Governor Pan Gongsheng clarified that only modest rate reduction will follow the Fed’s decrease, implying that there won’t be any significant loosening of monetary policy in response to the weak July economic statistics. According to Securities Times, the PBoC will prioritize putting this year’s new rules into effect. Additional actions will be taken in compliance with State Council directives. For CNY FX, geopolitical uncertainties continue to be a significant swing driver. 7.20 is still the next major resistance level for USDCNY. Important domestic data releases, such FDI and the China loan prime rate (5Y), should be watched by traders.
JPY Kishida’s exit spark Yen’s volatility. Fumio Kishida, the prime minister of Japan, has decided not to seek reelection in the September leadership contest of the ruling Liberal Democratic Party (LDP). The market may be more focused on the future prime minister and how their actions may affect BoJ policy as some market players believe that political pressure led to the BoJ’s rate hike last month. Chart shows suspected intervention dates in dark circles. Following the impulsive Jul-Aug decline, USD/JPY recovers from the first cluster of longer-term chart support levels at 140. Nearby resistance is located at the 200-day moving average (151.675), and the 148.758 Jan 2023 channel. Important domestic statistics to keep an eye on include the trade balance, CPIs, the Jibun Bank Japan manufacturing PMI, and orders for core machinery.
CAD Fundamentals justify further weakness. The Canadian dollar briefly strengthened past the C$1.37 mark ahead of the US CPI report amid hopes that the Fed would cut rates more aggressively. However, the Greenback has since recouped those minor losses, as yet another string of positive data soothed investor concerns about an increased risk of a US recession, leaving USD/CAD virtually unchanged for the week and holding above its 55-day moving average at C$1.3718. One-week USD/CAD implied volatility is trending downward, the lowest among G10 peers, and has reached a fresh four-year low. As it stands, a 25-basis point Fed rate cut in September is fully priced into the current CAD exchange rate, so the Loonie needs a fresh catalyst to fuel additional gains. Having said that, the latest domestic macroeconomic data remains non-supportive for the CAD, while the US economy continues to outperform. With the US-Canada economic surprise index differential at a two-month high, further USD/CAD upside is possible, offering an improved re-entry point for investors after trimmed record CAD short positions. Nonetheless, given the still highly elevated CAD short positioning, we maintain that USD/CAD gains will likely be limited.
AUD RBA’s hawkish stance keeps markets on edge. RBA Governor Bullock maintained her hawkish stance in her statement to the Australian Parliament after the August meeting and press conference. Bullock is firmly opposing rate reduction based on market pricing once more. Her remarks on Friday about the trade-off between the dual mandate goals of full employment and inflation are more aggressive, in line with Deputy Governor Hauser’s recent turn in that direction. Even with extremely high projections above market consensus, the RBA is more concerned with upside risks to underlying inflation. Its emphasis on perspective hazards is mostly global rather than national, with Bullock highlighting China in particular. We think that rates will likely stay higher for longer. After making a strong recovery from the 0.6346 2022–2024 pattern trend line, the AUD/USD pair remains in a jumbled range. We see resistance in the form of the adjacent moving average cluster and the 0.6628 Jul 61.8% retrace. This week’s economic schedule includes the MI leading index and the minutes of the RBA meeting.
