Market Brief: Dollar Retreats as Trump's Odds Slip 

Financial markets are in relief mode this morning after Taylor Swift endorsed Kamala Harris for president, reducing demand for hedges against a rally in the dollar or a resumption in trade war hostilities. The greenback is reversing its three-day rally, short-end Treasury yields are declining, and North American equity indices are retreating ahead of the open.

In related news, Harris managed to flip prediction market odds in her favour during a televised debate with former president Donald Trump. Economic policy details were limited, and neither of the candidates managed to land a knockout blow big enough to decide the race, but investors are growing more confident that an edge in the polls will translate into an electoral college victory for the current vice president. According to the PredictIt betting website, Kamala is now holding a nine-point lead over Trump.

Traders are now bracing for this morning’s consumer price index release, which is expected to show inflation running at a pace roughly consistent with the Federal Reserve’s target for a fourth consecutive month. The all-items price basket is seen rising 0.15 percent in August - matching July’s pace - while the more important core measure climbs 0.18 percent, slightly faster than in the prior month. On a year-over-year basis, that implies headline price growth around 2.5 percent - down from 2.5 percent previously - with core holding at 3.2 percent*, the same as in July. A deep undershoot could point to weakening demand in the US economy and help bolster the case for an unusually-large rate cut from the Federal Reserve at next week’s meeting. Futures markets are assigning circa-34-percent odds to a 50 basis-point move,

The Japanese yen is sitting on the biggest gain among major currencies after hawkish comments from a Bank of Japan board member helped put a rate hike on the table for coming meetings. Speaking with business leaders, Junko Takagawa said the “degree of monetary easing will be adjusted” if the economy continues to perform as forecast, noting that the “current level of real rates is extremely low”. Markets remain convinced that the central bank will deliver its next rate cut in December or January - once the August carry trade unwind and the US election are firmly in the rear-view mirror - but October odds have been creeping up in line with a continued strengthening in wage pressures.

The British pound is lagging broader market gains after gross domestic product flatlined for a second month in July, taking some air out of the ‘UK exceptionalism’ trade that has underpinned the currency through much of the year. According to the Office for National Statistics, overall economic output remained unchanged after a similar performance in June, with both the services and manufacturing sectors showing signs of weakness after having achieved a relatively-strong expansion in the first half. The Bank of England is still seen lagging its American counterpart, cutting rates at roughly half the Fed’s pace over the next year, but front-end gilt yields have softened, suggesting that the pound’s current valuation - near the highest levels since Brexit - could be a bit rich.

The Canadian dollar is also up, but is struggling to make headway after the Bank of Canada’s Tiff Macklem again appeared to suggest that 50 basis-point rate cuts could be on the table in future meetings, saying “it could be appropriate to lower rates more quickly” if inflation falls at an unexpectedly-rapid pace. The Governor, talking with reporters following a speech in London yesterday morning, was at pains to note that decisions would be taken “one at a time,” but repeated language used during last week’s press conference, alluding to the “bigger steps” that could be taken to provide economic accommodation in the months ahead. According to overnight index swap pricing, the likelihood of an oversized 50 basis-point move between the Bank’s October and December meetings is holding near the 65-percent level, suggesting that a significant share of market participants expect the economy to decelerate even more sharply.

Mexico’s peso continues to suffer turbulence as Andrés Manuel López Obrador’s judicial reform bill nears final Congressional approval. Earlier this morning, the Senate approved the general text of the legislation in an 86-41 vote - reaching the two-thirds majority needed for passage into law - and it will now go through a final debate and adjustment stage before landing on the president’s desk for signature. Opposition lawmakers, international observers, and financial markets have condemned the effort to expose the judiciary to popular elections, and the exchange rate has tumbled as investors have grappled with the prospect of a more capricious and corrupt operating environment.

The peso gained briefly last night as odds on a second Trump presidency were ratcheted down, but we worry that the country will almost-inevitably find itself on the wrong end of US political rhetoric in the months ahead. The last round of tariffs was an abject failure in terms of reducing the overall US trade deficit - as we and most other observers expected, the government’s balloon-squeezing effort simply moved bilateral imbalances around - but the threat of a renegotiation of the NAFTA 2.0 agreement, or the imposition of new tariffs remains real. During the debate, Trump said “They're building big auto plants in Mexico. In many cases owned by China. They're building these massive plants, and they think they're going to sell their cars into the United States because of these people. What they have given to China is unbelievable. But we're not going to let that. We'll put tariffs on those cars so they can't come into our country”. More talk like that, particularly if paired with a recovery in polling odds, could put renewed downward pressure on the peso.

*Note that although many of the underlying price indices used in calculating the Fed’s preferred personal consumption expenditures index are also present in the overall consumer price index, the latter is narrower, more heavily driven by housing prices, re-weighted less frequently, and calculated using a different formula. The core personal consumption expenditures index typically runs a little softer than its core consumer price index counterpart.

**Apologies for yesterday’s interruption in service. Travel-related delays prevented sending a note.

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