Market Brief: Foreshocks Rumble Financial Markets 

Seismic activity is intensifying across financial markets ahead of Friday’s non-farm payrolls report. A series of temblors hit during yesterday’s session, with Nvidia suffering the largest nominal one-day wipeout in market history, the S&P 500 falling by more than 2 percent, the VIX “fear index” jumping by more than a third, and currency markets seeing at least three wholesale trend reversals in the space of eight hours. Today looks set to deliver a more muted version of the same, with futures pointing to renewed selling, Treasury yields inching lower, and the dollar slipping against its major rivals ahead of the open.

The Institute for Supply Management's manufacturing index improved slightly in August, but remained consistent with a downturn ahead. The headline index climbed 0.4 percentage points to 47.2 - still below the 50 threshold that separates expansion from contraction - while softness in production backlogs and new orders pointed to a weaker buildup to the all-important fourth-quarter holiday season. The employment sub-index staged a modest improvement, yet remained firmly in negative territory, putting downward pressure on "whisper" estimates ahead of Friday's payrolls report.

The manufacturing sector now employs less than 8 percent of the US workforce, and tomorrow’s services data should carry more fundamental weight, but factory activity nonetheless plays a “canary in a coal mine” role in setting expectations for the wider economy. After yesterday’s print, futures markets are pricing in a 62-percent chance of a quarter-percentage-point rate cut from the Federal Reserve on September 18, with 37-percent odds on a half-percentage-point move.

Both the pound and the euro are holding recent gains, but are struggling to move higher. Cross-Atlantic gaps between economic surprise indices - which measure the difference between consensus forecasts and realised economic data over time - have narrowed materially over the last two months, helping sap currency market momentum, and a relative stabilisation in policy expectations is limiting the extent to which rate differentials support directional position-taking. The Bank of England is seen cutting rates five times over the next year, while six moves are priced in for the European Central Bank, broadly matching the spread that existed in January.

Investors overwhelmingly expect the Bank of Canada to deliver another rate cut this morning. Officials will not be delivering a new Monetary Policy Report or forecast update, there are already two more moves priced into overnight index swaps for the remainder of the year, and we don’t think policymakers are ready to spook investors or the general public with talk of supersized emergency cuts. This suggests that market reaction will be largely determined by nuances in the accompanying statement and post-decision press conference.

Governor Macklem is likely to double down on the dovish message transmitted during the summer’s decisions, emphasising signs of weakness in consumer demand, highlighting growing slack in labour markets, and pointing to a lack of momentum in the private sector. With inflation essentially at the central bank’s target and heading lower, borrowing costs are still in restrictive real territory, broadly justifying what is currently priced into overnight index swap markets - rate cuts at back-to-back meetings through early next year.

We don’t expect extreme moves in the loonie around the decision itself. Canadian policy rate expectations have ratcheted lower in the last two months, but market views on the Fed’s trajectory have moved even more aggressively, helping narrow interest differentials at the one-year horizon and beyond.

The July US Job Openings and Labor Turnover report is expected to provide further evidence of moderation in demand for workers, and the timing of its release - 15 minutes after the Bank of Canada’s announcement - could obscure currency market signals from the northern side of the border. The number of open jobs posted is seen stabilising in July relative to the previous month’s levels, but the ratio of vacancies to unemployed workers could fall further below pre-pandemic levels, and the quits rate - a reflection of worker confidence in their employment prospects - looks vulnerable to a move lower.

Taken in sum, currency markets appear poised for a serious reckoning on Friday morning, with price action likely to remain erratic in the coming days as traders seek to position themselves. It is important to avoid extrapolating developments too far forward - the noise to signal ratio in markets will remain extremely elevated - but it is equally important to seize fleeting trading opportunities as they are presented. Limit orders - which execute automatically at target market levels - can be enormously useful when rates move faster than human reaction times.

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