Market Brief: Markets go quiet ahead of US inflation update

The dollar is edging lower and trading ranges are narrowing across currency markets ahead of the personal consumption expenditures report—the Federal Reserve's preferred inflation gauge—at 8:30. Evidence of resilient underlying price pressures might reignite the dollar's rally—or a softer reading could open a wider reappraisal of the higher-for-longer policy expectations that have driven the currency's outperformance over the past week.

Equity markets are setting up for gains at the open after a blowout forecast from Micron restored confidence in the artificial intelligence boom. The memory-chip maker provided a quarterly revenue outlook well above analyst estimates, sending its shares more than 13% higher after the closing bell and lifting sentiment across the semiconductor complex.

Oil prices are nearing pre-war levels as flows through the Strait of Hormuz recover. US energy secretary, Chris Wright, yesterday said roughly 72 ships* carrying 20 million barrels of crude had moved through the strait over the prior 24 hours, close to a fifth of daily global consumption and broadly in line with volumes seen before the conflict with Iran. Brent is going for $73 a barrel, while West Texas Intermediate trades for less than $70—up from its starting levels this year, but down more than 20% in June alone.

The Canadian dollar is trading near levels reached in the immediate aftermath of last year's ‘Liberation Day’ tariff announcement. Two-year US-Canada yield spreads have widened sharply since early May, reflecting a hawkish repricing in American policy, persistent cross-border trade tensions, a plummeting domestic housing market, and a view that the Bank of Canada intends to look through commodity-led inflation as it sets policy for a weak economy. The move looks stretched, however—from a technical standpoint, the loonie hasn't been this oversold since 1985—and articles in national newspapers are calling for another 1,000-pip drop from here, a contrarian signal if there ever was one**.

Other major currencies are rangebound, with near-term direction more likely to be determined by this morning's American inflation print than by anything domestic. The euro and the pound are each holding just above key technical levels, while the Japanese yen remains trapped in an intervention-defined orbit around the 161 mark.

The Mexican peso is trading slightly lower in the run-up to this afternoon's Bank of Mexico decision. The meeting is shaping up as a non-event, with the policy rate expected to stay at 6.50% and forward guidance likely to remain carefully non-committal after officials signalled last month that the easing cycle had run its course—but there is, as always, potential for a bigger move if there are any hints of an imminent tweak in the spread between Mexican and US rates***.

In the background, however, foreign exchange volatility expectations are ratcheting higher as investors brace for a divergence in central bank trajectories, with the Federal Reserve seen tightening while its peers move to the sidelines. But markets may have misread Kevin Warsh's comments during last week's press conference as a signal of a fundamental shift in the Fed's reaction function, rather than a performative effort to burnish his inflation-fighting credentials after being nominated by President Trump. In my view, traders are now embedding too much tightening into the dollar, and this mispricing could correct abruptly.

Volatility is coming, but it may arrive from the opposite direction to the one markets are leaning toward, through a softer dollar rather than a stronger one. Hedgers beware.

*We suspect this is fairly accurate, but it’s important to note that official tracking data isn’t showing numbers nearly this high, with many ships transiting the Strait with their Automatic Identification Systems turned off.

**Widely-loved "permabear" David Rosenberg penned an article in today’s Globe and Mail arguing that the loonie should fall to 1.53 (from near 1.42 this morning). I'm a fan—Rosenberg is one of the best, and most entertaining—economists working globally, but it may be worth reviewing previous calls (see here, here, and here) and considering what's already priced in before trading on this information.

***Banxico tends to maintain a sizeable gap between its policy rate and the Fed's, keeping Mexican rates well above US equivalents in order to preserve the peso's appeal to investors, discourage destabilising capital outflows, and contain the imported inflation that a weaker currency would bring. This is catnip for currency speculators, but often leads to a "picking up nickels in front of steamrollers" **** dynamic in the peso.

****You pick up small gains for a long time and then get run over by something you should have seen coming.

Market Overview

Data as of 7:15 AM EDT

Notes: DXY: Dollar index, DMA: Daily Moving Average, Pivot points are calculated on a one-month basis, 3-month and 10-year spreads are against USD, Implied V.: implied at-the-money option volatility

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