Market Briefing: Currency Markets Reverse Direction on Narrowing Yield Gaps
The dollar is tumbling as currency traders unwind wagers on ever-widening gaps between the world’s major central banks. With the Bank of Japan inching closer to a shift in policy direction, the European Central Bank making hawkish noises, and an energy price cap reducing pressure on the Bank of England, yield differentials are moving in a more synchronized fashion than in recent months - and evidence of a slowing in the Chinese economy is helping reduce the greenback’s safe-haven appeal.
The pound is recovering after new Prime Minister Liz Truss announced plans to hold average household energy bills at no more than 2,500 pounds from October 1, reducing the likelihood of an inflationary overheat that forces the Bank of England into raising rates more quickly. Prior to the announcement, the exchange rate broke through its 2020 nadir, briefly reaching levels last seen in 1985.
Bank of Japan Governor Haruhiko Kuroda called sudden declines in the yen “undesirable” after a meeting with senior government officials, triggering a sharp reversal in foreign exchange markets. Responding to growing alarm among households and the business community, policymakers have stepped up jawboning efforts in recent weeks, making policy changes or some sort of market meddling more likely - even if such efforts pale in comparison with the 1985 Plaza Accord or the repeated interventions of the late nineties. The yen climbed more than 1 percent in overnight trading as traders cut exposures.
Markets doubled down on bets the European Central Bank will hike rates by another 75 basis points at next month’s meeting, after several media organizations reported that Governing Council members — and Chief Economist Philip Lane — had turned markedly more hawkish in recent weeks. Swap rates suggest roughly 65 basis points in tightening is now priced in for the October decision. The euro is trading slightly above parity after falling below 99 cents earlier in the week.
The British pound is more than 1 percent against the dollar but remains near multi-decade lows as the nation mourns the death of Queen Elizabeth II, the nation’s longest-serving monarch. Official activity has been suspended for a ten day mourning period, and the Bank of England has postponed a meeting originally scheduled for next week, leaving markets to focus on the fiscal and inflation implications associated with the government’s plan to cap energy prices. The Treasury’s borrowing is likely to increase as the plan is rolled out, but economy-wide price growth should subside, putting pressure on the long end of the gilt curve while lowering short-term rates.
Chinese inflation decelerated in August, with consumer prices rising just 2.5 percent year-over-year, down from 2.7 percent in the prior month. With real estate markets slumping, a record-setting drought forcing rolling blackouts, and coronavirus lockdowns hitting major provinces with disquieting regularity, households are increasing precautionary savings and cutting spending levels. As Western demand for manufactured products ebbs, businesses are growing more reluctant to raise prices.
To some extent, this is helpful for the global economy: by limiting demand for raw materials and putting downward pressure on producer prices, a slowing China should help ease inflationary pressures in the rest of the world.
The Canadian dollar is climbing, lifted by yesterday’s hawkish comments from the Bank of Canada’s Carolyn Rogers, along with a broader improvement in risk appetite. Speaking in Calgary, the Deputy Governor warned rates would need to go higher, saying “Because we are in a period of excess demand, we need a period of lower growth to balance things out and bring demand back into line with supply”. She also noted that the loonie had failed to play its historical role in insulating the economy against commodity price inflation, saying “There is an expectation for the Canadian dollar to go up, we’ll see if that happens. But it would be nice to get that buffer”.
In a few minutes, Statistics Canada is expected to report a 15,000-position job gain for August, but currency markets are unlikely to take it too terribly if the number disappoints. The Canadian jobs market remains incredibly tight from a historical perspective, giving central bankers enough room to raise rates without fearing an imminent collapse in employment.
KARL SCHAMOTTA, CHIEF MARKET STRATEGIST
CAD Unemployment Rate, August
USD Baker Hughes Weekly Rig Count
GBP Gross Domestic Product, August
GBP Trade Balance, July
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USD Consumer Price Index, August
GBP Consumer Price Index, August
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GBP Bank of England Bank Rate
USD Weekly Jobless Claims
USD Retail Sales, August
CAD Existing Home Sales, August
CAD Housing Starts, August
USD University of Michigan Sentiment, September (Preliminary)
USD Baker Hughes Weekly Rig Count
EUR European Central Bank Speech, Rehn