Market Brief: Second Trump Assassination Attempt Leaves Markets Unruffled

Financial markets are calm and there are no signs of a resurgence in the ‘Trump trade’ after Secret Service agents fired on a gunman at the former president’s Florida golf course. Prediction markets are still showing Kamala Harris holding a slight lead in the race to become the next US president, and assets that might benefit from a policy mix defined by tighter immigration, looser regulations, greater protectionism, and higher inflation - the dollar, Treasury yields, and bank, health, and energy stocks - are broadly softer. The euro, pound, yen, and Australian dollar are all up more than half a percent against the greenback amid relatively thin trading conditions.

Uncertainty is high ahead of Wednesday’s Federal Reserve decision. For the first time in recent memory, the outcome hasn’t been fully telegraphed in advance, and there are huge unknowns around what officials will signal about their future intentions in the accompanying “dot plot” summary of economic projections.

Tomorrow’s retail sales report is unlikely to clarify matters. Headline receipts are widely seen falling on a month-over-month basis in August as auto sales slumped, but “control group” sales - which exclude food, vehicles, gas, and building supplies - may have risen 0.3 percent, underlining continued resilience in underlying consumer demand. Slowing labour markets, weakening income growth, and falling savings rates have thus far failed to dent spending levels, with July’s print surprising to the upside, and the higher-frequency Johnson Redbook measure showing no evidence of the sort of declines that came ahead of recessions earlier this century.

We think the odds slightly favour a half-percentage point rate cut, with the dot plot pointing to two additional quarter-point moves before year end, but this is not a high-conviction call. There are clearly wide differences of opinion on the Federal Open Market Committee, as exhibited in the wide variety of perspectives offered before the blackout period began last Saturday, and in the articles penned by the Wall Street Journal’s Nick Timiraos and the Financial Times’ Colby Smith on Thursday. A dovish contingent - perhaps led by Chair Powell - seems to be working to convince more cautious participants of the need to move more aggressively, but we simply don’t have a view into how those negotiations are progressing*.

The dollar could rebound in the weeks ahead under either scenario. With markets arguably priced for perfection - relentlessly-dovish messaging from Fed officials, steadiness across a number of key domestic economic variables, stability in global growth levels, and narrowing cross-currency rate differentials - recent exchange rates moves look overdone. Historical patterns would suggest that selling of the greenback might accelerate in the weeks immediately following the Fed’s first rate cut, but that this will ultimately rebound as spillovers hit monetary policy expectations elsewhere.

We doubt Canada’s inflation print will have a meaningful impact on monetary policy expectations. The headline all-items index is seen rising 2.1 percent in the year to August, down from 2.5 percent in the prior month on a drop in gasoline prices, while an average of the Bank’s preferred core measures should continue their moderation. Elevated rent and mortgage interest costs - both heavily influenced by the Bank of Canada’s past policy actions - remain the most significant factors keeping headline inflation slightly above target, and officials have clearly shifted focus toward other, more pressing matters.

Bigger rate cuts are clearly on the table. In an interview with the Financial Times over the weekend, Governor Macklem said “As you get closer to the target, your risk management calculus changes. You become more concerned about the downside risks. And the labour market is pointing to some downside risks”. There’s already “enough slack” in the economy to bring inflation down, he said, suggesting that officials could switch to cutting rates in 50 basis-point increments in coming months if growth undershoots their forecasts. Markets have 74 basis points in easing priced in before year end, implying at least one jumbo-sized move in October or December.

Japan’s yen is building momentum for a decisive push through psychological resistance at the 140 threshold ahead of Friday’s central bank meeting. No policy changes are expected, but after a series of hawkish pronouncements from officials in recent weeks, the Bank of Japan’s direction of travel is clear, and Governor Ueda seems likely to begin preparing markets for another rate hike before year end - a move that would narrow interest differentials relative to the United States. The exchange rate has risen almost 16 percent since reaching a nadir in early July, and punters are piling in, with last week’s data showing speculators building the biggest long position since 2016, mirroring a collapse in long bets on the Mexican peso.

Currency markets tend to overshoot**, but the yen’s advance could find itself in rarefied air in the weeks ahead. With overnight index swap prices showing the Bank of Japan hiking at least once over the next year, and the Fed seen delivering a total of ten cuts over the same time period, we suspect the divergence in cross-Pacific policy trajectories is now almost fully priced in, meaning that the exchange rate might need a new catalyst for movement after breaking into the 130's.

*To be frank, tossing a coin might be more effective than any sell-side analysis in determining which way this decision might go. To be even more frank, tossing a coin might be the best way to forecast most moves in the financial markets.

**This may or may not be news to regular readers.

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