Market Briefing: Markets Fall Upward on Recession Concerns
Markets are rallying into month end after data showing a decelerating US economy convinced investors that inflation will subside and the Federal Reserve will raise rates more slowly. Equities are setting up for another strong open, Treasury yields are up, and both major crude benchmarks are sitting on solid gains. The trade-weighted dollar is retreating, although it remains roughly 1.2 percent higher on the month.
US gross domestic product shrank in the second quarter, touching off a debate over whether the economy is in recession or not. That controversy is largely irrelevant to foreign exchange markets - for currency traders, what matters is whether the ongoing deceleration leads the Federal Reserve to slow or pause its rate hiking cycle. Long-term interest rates - which exert gravitational forces on asset prices - are down sharply from levels that prevailed prior to yesterday’s data release, and are vastly lower relative to mid-June.
European inflation came in hotter than expected, but growth also surprised to the upside. Data released earlier this morning showed prices in the common currency area rising 8.9 percent year-over-year in July and output expanding 0.7 percent in the second quarter. The euro initially climbed on bets the European Central Bank would raise rates more aggressively, but gains are dissipating as traders square positions ahead of a month in which geopolitical tensions are likely to put more pressure on the economy.
The Japanese yen is climbing, up another percentage point in overnight trading and coming closer to a technical breakthrough to the topside. The currency has gained as commodity prices - primarily fuel and energy - have dropped, and as interest differentials with the US have narrowed. The unfolding price dynamics bear all the hallmarks of a slow-moving short squeeze.
Markets think the Fed’s preferred inflation measure accelerated in June. The core personal consumption expenditures price index, due at 8:30 am, is expected to increase 0.5 percent month-over-month, up from 0.3 percent in May.
US consumer spending likely remained strong, as household purchasing patterns continued to defy a worsening economic outlook. Consensus forecasts suggest overall outlays rose 0.9 percent in the month, with personal income climbing 0.5 percent.
Wage gains are expected to slow when the Labor Department releases its latest employment cost index at 8:30. Wages and benefits for civilian workers are thought to have increased a seasonally adjusted 1.1 percent in the second quarter, down from 1.4 percent in the first three months of the year.
Canadian growth might have hit a pothole, but a rebound is likely for June. Statistics Canada is expected to report a 0.2 percent decline in gross domestic product in May, aligning tightly with a preliminary estimate published last month. But with consumers continuing to spend, auto plants reopening, and activity in the energy sector ramping up, the agency’s forward-looking projection for June should move back into positive territory. Note that the Canadian economy typically follows the US into a downturn at a lag.
Inflation and growth expectations should remain unchanged when the University of Michigan publishes its final consumer sentiment index for July at 10 am - but revisions in prior months have dramatically shifted outcomes.
KARL SCHAMOTTA, CHIEF MARKET STRATEGIST
CAD Gross Domestic Product, May
USD Personal Consumption Expenditures, June
USD Employment Cost Index, Q2
USD University of Michigan Consumer Sentiment, July (Final)