Market Brief: Currencies Stabilise as Expected Growth Differentials Narrow 

CalendarApril 23, 2024

The dollar is holding steady and Treasuries are stable ahead of auctions that could see yields hold above the 5-percent threshold for the first time since November. The US will sell a record $69 billion in two-year notes later today, followed by $70 billion in five-year paper tomorrow, and another $44 billion in seven-year maturities on Thursday, testing investor demand for yields that could look attractive if the Federal Reserve eases aggressively in the latter half of the year - but might look too cheap if rate cuts are further delayed.

The “term premium” - the extra compensation investors demand for bearing the risk of interest rate changes over time - is creeping higher, but remains below zero. This suggests markets remain relatively unworried about sticky inflation eroding real returns, deglobalisation lowering inward investment flows, rampant deficit spending raising debt to levels that exceed underlying demand, or the Fed persistently reducing its intervention efforts. It is fair to wonder how long this can last.

The euro and pound are both gaining against the dollar after survey data showed private-sector activity accelerating to the fastest pace in a year. S&P Global’s euro area composite purchasing manager index climbed to 51.4 in April, well above the 50 threshold that separates expansion from contraction, and topping forecasts set at 50.7. Services sector growth helped the German economy overcome persistent manufacturing weakness to eke out a small expansion. French data also exceeded expectations. And the UK composite climbed to 54 from 52.8 in March, indicating that the economy is recovering snappishly from last year’s mild downturn. In comments released a short time ago, Bank of England chief economist Huw Pill said that his views on inflation and the economy had not changed since early March, suggesting that rate cuts could begin later than markets had begun to believe.

Japan’s yen is also trading on a slightly stronger footing after officials stepped up jawboning efforts. Speaking last night, Finance Minister Shunichi Suzuki warned “I think it’s fair to assume that the environment for taking appropriate action on forex is in place” - phrasing that suggests the central bank has been instructed to prepare for intervention if the Ministry authorises action. But rate differentials remain vast, realised volatility levels are holding near two-year lows, and the yen’s declines have been paced by other major currencies in recent weeks. Gains could prove difficult to sustain without a more aggressive monetary policy shift from the central bank itself - perhaps a reduction in bond buying announced at Friday’s meeting?

The Canadian dollar continues to recover ground after last week’s flight to safety drove it below the 1.3800 threshold. Some have argued that rate cuts delivered by the Bank of Canada as early as the June meeting could cause the currency to “crater”, but we think the Bank’s likely trajectory has been well understood for months. Canadian overnight index swaps - which measure implied policy moves - have been fairly stable since February, with Fed expectations shifting far more dramatically. Between two and three cuts are priced into the Canadian dollar’s current value, meaning that the Bank will have to deliver more than that to drive the currency lower - or the Fed will need to turn more hawkish.

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Karl Schamotta

Karl Schamotta

Chief Market Strategist

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