Market Brief: Calm After the Storm Brings Currency Volatility Down

CalendarApril 12, 2024

Treasury yields are stabilising and the dollar is recovering ground after losing a little altitude during yesterday’s session when a closely-watched input cost index climbed by less than expected. The producer price index for final demand rose just 0.2 percent month-over-month in March, with a third consecutive increase in services costs obscuring a cooling in many of the components that go into the Fed’s preferred inflation indicator. Taken in combination with Wednesday’s consumer price print, the data suggest that the personal consumption expenditures index will rise somewhere between 0.2 and 0.3 percent on a month-over-month basis when the next update is published on April 26 - a pace that won’t give central bankers licence to begin loosening policy, but also shouldn’t compel further tightening.

Overall currency market volatility is reverting toward levels that prevailed prior to Wednesday's inflation shock, suggesting that risk-taking activity - like borrowing yen and buying Mexican peso - is likely to continue.

The euro is trading near a five-month low after the European Central Bank strongly hinted it was prepared to pre-empt the Fed in cutting rates this summer. In the announcement setting out yesterday’s unchanged policy decision, officials said if incoming data further increase the central bank’s “confidence that inflation is converging to the target in a sustained manner, it would be appropriate to reduce the current level of monetary policy restriction” and Madame Lagarde followed up by saying “We are not Fed-dependent,” noting that several Governing Council members favoured cutting immediately. We would warn that the first cut could be a hawkish one though - with energy price risks growing once again, policymakers are unlikely to welcome market bets on a rapid-fire easing cycle, or to permit a wide gap to open relative to US rate expectations.

The British pound is trading with a slightly stronger bias after gross domestic product data showed the economy eking out a small 0.1-percent gain in February. With growth in the prior month revised higher to 0.3 percent from 0.2 percent, it looks as if the economy is pulling out of last year’s mild recession - but so slowly that the Bank of England shouldn’t face meaningful upside risks when it begins to deliver rate cuts later in the year.

Today’s economic calendar looks light, with the University of Michigan’s uselessly-partisan consumer sentiment survey due at 10:00, and Fed officials including Boston’s Collins, Kansas City’s Schmid, Atlanta’s Bostic, and San Francisco’s Daly scheduled to speak during the day.

The cadence of data releases will drop next week: The US will release March retail sales on Monday, with markets expecting a modest rebound in “control group” receipts as underlying consumer demand remains strong. China will publish first-quarter gross domestic product numbers, which should show growth slowing slightly. Canadian headline and core inflation numbers, due on Tuesday, might follow US trends in popping higher, but weak domestic demand should keep the Bank of Canada’s preferred measures relatively restrained. And although Wednesday’s British consumer price index data could show overall inflation heading in the right direction, constrained supply in the services sector will likely keep investors guessing on the Bank of England’s rate trajectory.

We remain alert to signs of intervention in the Japanese yen during North American trading hours. With the dollar-yen exchange rate floating near a 34-year low and Ministry of Finance officials delivering increasingly strident warnings on a daily basis, a move has become increasingly likely. We don’t think central bank buying will dramatically reverse the currency’s fortunes - rate differentials remain far too wide to support a sustained rally - but authorities have previously achieved success in timing their efforts to land after Tokyo’s markets have closed.

On a side note: Gold prices are marching higher as tensions in the Middle East threaten to boil over and inflation worries resume. Or they seem to be. Other indicators of risk aversion are hardly pointing to a high level of global concern over the conflict between Israel and Iran, and inflation breakevens still suggest that investors see price growth reverting to normal over the coming years. With the caveat that I’m not a gold market expert, and could very well be missing something fundamental in how the physical market is functioning, it seems more likely that a form of capital flight is taking place in China. The spread between gold prices in Shanghai and London, when adjusted for exchange rate depreciation, has blown out to record levels when viewed on a monthly basis:

Chinese investors, depressed about the prospects for domestic housing and equity markets, and stymied by capital controls and cryptocurrency bans, may be moving money into physical gold, putting upward pressure on global demand. This is then generating “fear of missing out” speculation from a contingent of Western investors, some of whom seem broadly convinced that this represents the beginning of the end for the fiat currency system. If so, the biggest risk to gold prices could come from renewed stimulus efforts in China, not from any shift in the geopolitical landscape or change in Western central bank policy.


Karl Schamotta

Karl Schamotta

Chief Market Strategist

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