Market Brief: Dollar Stalls as Risk Appetite Ebbs

The dollar is trading below last week’s one-year high this morning, with softness in equity markets helping limit marginal flows into the US financial system. The S&P 500 has given back more than half of its post-election gains on a more hawkish outlook for monetary policy - and some scepticism on the earnings front - ten-year Treasury yields are holding at around 4.46 percent, and risk appetite is ebbing across a range of asset classes.

Data last week showed the US economy maintaining strong underlying momentum. Retail sales increased slightly more than expected in October, suggesting that consumer demand is plateauing at remarkably high levels: receipts climbed 0.4 percent after an upwardly-revised 0.8-percent advance in September, while the “control group” measure - excluding auto dealers and gas stations, building materials, and office supplies - shrank -0.1 percent from an improved 0.7-percent gain in the prior month. Separate inflation data - consumer, producer, and import prices - bolstered market confidence in a 0.3-percent monthly print for the Fed’s preferred measure of inflation - the core personal consumption expenditures index - next week.

Federal Reserve officials sound confident. In a speech on Thursday, Jerome Powell said the disinflationary path could be “bumpy” at times, but that the economy was looking “remarkably good”. Odds on a December rate cut fell to less than 60 percent after he said "the economy is not sending any signals that we need to be in a hurry to lower rates".

The Mexican peso is trading on a slightly stronger footing after the government unveiled an aggressive plan on Friday to cut budget deficits. Under finance minister Rogelio Ramirez de la O’s proposed budget, the Sheinbaum administration will reduce the gap between revenues and expenditures to 3.9 percent of gross domestic product next year - down from an estimated 5.9 percent this year - by making deep cuts to spending across a number of areas, including public investment, health, and defence. If carried out, the projected drop in net borrowing would amount to the biggest fiscal consolidation since the early nineties and could help to put the country’s finances on a better footing - but will also reduce the economy’s capacity to withstand the changes in trade and remittance flows that are expected under a second Trump administration. Ahead of the budget, Moody’s lowered its outlook on Mexican government debt to “negative”, giving the country a rating just two steps above junk.

The Japanese yen is back under pressure as traders downgrade the likelihood of a December rate hike from the country’s central bank. In a widely-anticipated speech yesterday, Governor Kazuo Ueda avoided telegraphing an imminent move, saying that the Bank of Japan would likely keep tightening policy if its forecasts are realised, but “The actual timing of the adjustments will continue to depend on developments in economic activity and prices as well as financial conditions going forward”. A steady widening in rate differentials against the US dollar has weighed on the yen in recent months, and we struggle to see this reversing in the absence of a decline in Treasury yields.

First-tier releases will slow to a trickle in the United States this week, but political developments could keep traders on their toes. Donald Trump is believed to be broadening his search for the next Treasury Secretary, reportedly seeking someone better looking*, more amenable, and less likely to upset Wall Street than either of the two current front-runners - Howard Lutnick and Scott Bessent. If a decision is reached, traders will buy or sell the dollar based on the nominee’s views on tariffs, and on the degree to which the president is seen to be placating markets. This is because - to some extent at least - equity market indices seemed to act as a countervailing force during the first Trump administration, telling the president when to pull back on policies and when to double down. If a repeat is in the offing, the dollar might lose some altitude.

In theory, tomorrow’s Canadian inflation report could influence preliminary expectations for the central bank’s next decision, but in practice, we suspect that the rate cut’s sizing will ultimately hinge on other factors. Consumer prices are seen rising 0.3 percent month over month in October - putting headline inflation on track to accelerate toward 1.9 percent on a year-over-year basis - while the core measures preferred by the Bank of Canada (trimmed mean and weighted median) should remain well below target, especially once shelter costs are excluded. While this alone is unlikely to justify a second outsized cut, it may, when combined with a weak third-quarter gross domestic product print, a soft jobs report, and heightened protectionist rhetoric from the incoming Trump administration in the coming weeks, pave the way for a half-percentage-point move in December. At the moment, traders are assigning circa 45-percent odds to a second consecutive 50 basis-point cut.

Traders are bracing for some upside risk in Wednesday’s UK consumer price index release, with the Office for National Statistics seen reporting a sharp rise in headline inflation after a household energy price cap was lifted by 9.5 percent last month. The Bank of England’s preferred measure of services inflation is expected to climb to 5 percent from 4.9 percent in September, helping bolster the case for a pause in the central bank’s rate-cutting cycle at next month’s meeting. The economy showed clear signs of slowing momentum in last week’s data, but underlying price pressures remain fairly strong, suggesting that policymakers will follow a more gradual easing trajectory than their European counterparts over the year ahead. We think the pound could rise off six-month lows in the coming days.

Friday’s raft of purchasing manager indices could shed light on whether the global industrial cycle has bottomed out. Flash purchasing manager indices from the euro area, UK, Japan, and US are expected to show continued improvement - particularly among American manufacturers after the early November election - but a big question remains around whether the outcome will trigger a sugar rush as companies “front-run” potential tariffs, or simply dampen business confidence in countries outside the US. The answer - which will take time to clarify - could prove vital in determining exchange rate developments over the coming months.

*Appearances can play an important role. We've long believed that former Bank of Canada Governor Mark Carney’s good looks helped bolster confidence in Canada's banking system during the global financial crisis, convincing investors that the country’s households couldn’t possibly be engaged in the same behaviour as their US counterparts (reader: they were and are), while contributing to a persistent overvaluation in the Canadian dollar. A similar effect may have been in play during Paul Volcker’s time at the head of the Federal Reserve - other policymakers may have wanted to oppose his drive to raise interest rates into the stratosphere, but who in their right mind wants to argue with a 6 foot, 7 inch** dude who chomps cigars like they’re candy?

**The height of the next Fed governor could be key for Treasury markets.

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