Market Brief: Currencies Lose Momentum as Caution Sets In

The euro, pound, and yen are essentially flat against the dollar this morning as month end flows begin to dominate the foreign exchange landscape, with market participants generally inclined to cut leverage ahead of what could be an extremely dangerous September.

Data releases continue to paint a mixed picture of fundamental developments in the US economy.

Yesterday’s July durable goods report beat expectations on the headline level, but proved disappointing on closer examination. Overall orders climbed 9.9 percent from the prior month, but this was largely due to a jump in aircraft orders, which rose almost $23.4 billion after falling by -$4.2 billion in June. Shipments of core capital goods - excluding defence and aircraft - slumped -0.4 percent month over month in July, pointing to continued softness in underlying demand. Gross domestic product estimates for the beginning of the third quarter are coming under modest downward pressure.

This morning’s Conference Board measure of consumer confidence could bear the imprint of a slowing jobs market. If respondents echo July’s negativity on labour market conditions, investors will brace for a continued rise in the unemployment rate in August’s data - due for release at the end of next week - with attendant consequences for odds on a plus-sized move at the Federal Reserve’s September meeting, and for the yield-driven dollar.

Friday’s personal consumption expenditures price index release is fairly unlikely to surprise markets. Key components have already been published, and the consensus sees core prices rising 0.2 percent in July from the prior month, bringing the three-month annualised pace down to 2.1 percent - just slightly above the Fed’s target. Consumer spending is seen climbing 0.5 percent, marking the fastest growth in four months.

But Nvidia is slated to release its fiscal second-quarter results tomorrow afternoon, and high-beta currencies - like the Australian and Canadian dollars - are very likely to move in response as risk appetite shifts. The ‘magnificent seven’ stocks are - on paper - worth considerably more than any national equity market outside the US, and Nvidia has become a bellwether for the global capital investment cycle, making founder Jensen Huang something of a rock star (see debatably safe-for-work link here). We have no particular insight into how long this can be sustained, but there’s little doubt that investors will face an increasing risk of disappointment as time progresses.

The Canadian dollar is inching higher, benefitting from a broad-based decline in the greenback and a relative improvement in flow fundamentals. The Bank of Canada is still expected to ease policy at an aggressive pace over the next two years - eight rate cuts are priced in - but the Fed is seen slightly outpacing it, with at least nine moves implied in futures market pricing over the same horizon. Interest rate relief is likely to ease pressure on the country’s incredibly-indebted private sector. Oil prices are playing a more supportive role. And bearish speculators are being forced out of their positions.

The loonie’s political risk discount is also dissipating: Canada’s decision to impose punitive tariffs on Chinese electric vehicle, aluminum, and steel imports should help reduce friction with Washington and limit the country’s vulnerability to another round of trade disruption - even if Donald Trump wins the upcoming election. Ottawa yesterday announced plans to add a 100-percent surtax on Chinese-made electric and hybrid passenger vehicles on top of the 6.1-percent tariff previously applied, to hit steel and aluminum imports with a 25-percent levy, to launch consultations on other categories including batteries, semiconductors, solar products, and critical minerals, and to limit environmental subsidies to “products made in countries which have negotiated free trade agreements with Canada”.

If Mexico follows suit, with China-focused tariffs then applied relatively consistently across the North American free trade zone, the peso could gain some lift - but this might not be enough to brighten the currency’s longer-term outlook. President Andrés Manuel Lopez Obrador’s effort to remake the country’s judicial system gained momentum yesterday, with a Congressional constitutional committee voting to advance a draft resolution that would require that all federal judges be elected by popular vote - a move that is widely viewed as likely to diminish legal independence and remove checks and balances on the government’s power. With infrastructure issues hobbling investment, “friend-shoring” narratives losing momentum, and fiscal concerns growing, the peso has struggled to hold gains in the last month, and speculative positioning on the currency has fallen sharply. Further unwinding seems likely in the weeks ahead if background volatility rebounds and funding currencies like the yen appreciate against the dollar.

More broadly, if you trust the International Monetary Fund’s projections, global current account imbalances will narrow further this year as commodity prices normalise, Western governments reduce fiscal spending, and China’s surplus shrinks. If you don’t - and Brad Setser’s research persuasively suggests that you shouldn’t - it seems likely that tariff-heavy efforts to counter China’s demand repressive and export-focused growth model are mainly succeeding in reducing global supply chain efficiencies and reducing potential growth rather than minimising trade deficits. Another round of conflict is brewing, and we think Western countries will eventually conclude - against heavy opposition from the financial sector - that domestically-focused policy shifts (like addressing tax-driven savings and demand imbalances and imposing controls on inward capital flows) have become necessary.

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