Market Brief: Risk appetite fades on China slowdown fears

The US dollar is stronger against all its major counterparts this morning, building on August’s 1.7-percent gain as weak Chinese data weighs on global risk appetite. US equity futures are setting up for a modestly-weaker open and Treasury yields are up across the curve, helping keep the trade-weighted greenback near six-month highs. 

Global commodity prices are under pressure, the euro is softer, and both the onshore and offshore Chinese yuan pools are trading below 7.30 to the dollar after the private-sector Caixin services purchasing manager index dropped to 51.8 in August from 54.1 in July (the 50 level marks the boundary between expansion and contraction). The data suggest that an early-year post-lockdown rebound has run its course, leaving the economy struggling with a simultaneous slowdown in both of the last decade’s most powerful growth engines: exports and property speculation. Policymakers remain hesitant to flood the economy with credit, and traders are convinced that the People’s Bank of China will eventually relent in its defence of the 7.30 exchange rate, permitting a more sustained decline toward 7.45 - or beyond. 

The Australian dollar is lower after the Reserve Bank of Australia kept interest rates unchanged at 4.1 percent for a third straight meeting, maintaining a relatively hawkish bias in its statement while noting potential downside risks emanating from China’s property-sector meltdown. Policymakers subtly acknowledged signs of slowing in the domestic economy and an easing in labour market conditions, and said “Some further tightening of monetary policy may be required to ensure that inflation returns to target in a reasonable time frame, but that will continue to depend upon the data and the evolving assessment of risks” - potentially foreshadowing the Bank of Canada’s rhetorical approach in tomorrow’s decision. 

Canada's loonie is exchanging hands on the colder side of 1.36 as traders become increasingly convinced interest rates have already peaked. Data released ahead of the Labour Day long weekend showed the economy contracting -0.2 percent in the second quarter as consumer spending cooled and residential housing investment imploded - adding to evidence of a slowdown in labour markets to suggest that the Bank of Canada might opt to stay on the sidelines through the early part of next year. From a technical perspective, the risk of an overshoot into the 1.38’s is growing - with tomorrow’s rate decision, Thursday’s speech from Tif Macklem, and Friday’s jobs numbers all looming as potential catalysts - but we think such a move could prove short-lived as US data begins to deteriorate in coming weeks. 

Implied volatility in equity, Treasury, and currency markets remains remarkably low after last week’s data helped support hopes for a soft landing in the American economy: 187,000 jobs were added to non-farm payrolls in August, and consumer spending grew 0.8 percent in July while the Federal Reserve’s preferred inflation measure rose just 0.2 percent. We doubt this sense of calm will survive contact with this autumn’s economic data prints, and suspect that both implied and realized volatility in currency markets is set to rise as central banks set out on increasingly-divergent paths. 

Still Ahead

TUESDAY

US factory orders - a proxy for tangible goods demand - are expected to fall 2.3 percent in July relative to the prior month. (10:00 EDT)

WEDNESDAY

Bank of England Governor Bailey and three of his colleagues will deliver testimony in front of the Treasury Select Committee, with elevated wage growth likely to feature as a key vector of questioning ahead of the September 21 rate decision. (9:15 EDT)

The Bank of Canada is almost-universally expected to maintain its benchmark rate at 5 percent, responding to signs of cooling economic activity and easing price pressures in electing to stay on the sidelines. Policymakers could try to embed a relatively-hawkish message in the statement-only decision, but markets are prepared to ignore this after a series of recent data releases surprised to the downside. Odds on another rate hike in this cycle have plunged in the last week, with traders beginning to prepare for a cut as early as January 2024. (10:00 EDT)

THURSDAY

Governor Tiff Macklem will deliver the Bank of Canada’s latest Economic Progress Report in Calgary, helping shed light on the thinking behind Wednesday’s rate decision. We think he will follow in Jerome Powell’s footsteps, arguing that - although signs of slowing economic momentum and disinflationary forces are everywhere - real rates should remain elevated until price pressures have been decisively defeated (text published at 13:55 EDT, press conference follows the speech). 

A flock of Fed officials, including Raphael Bostic, Lorie Logan, and John Williams will speak through the day.

FRIDAY

Statistics Canada is expected to report a modest rebound in employment numbers, with roughly 15,000 jobs added in August. The unemployment rate - a function of population growth and labour demand - could climb for a fourth month, further reinforcing perceptions of a Canadian economy that is gearing down as the private sector’s debt servicing costs ratchet ever higher. (08:30 EDT)

See our Economic Calendar for a more complete listing of upcoming data releases.