Market Brief: Stress eases, currency markets mean-revert

Financial markets are stabilising this morning as credit concerns and trade tensions begin to subside. After a brief period of whiplash on Friday, the dollar is inching higher against a basket of its most-traded rivals, benchmark ten-year Treasury yields are holding just above the 4 percent threshold, and US equity futures are pointing to a stronger open. Most major pairs are back to Thursday levels.

Measures of implied volatility are slipping from levels hit last week when losses relating to an auto parts supplier and a subprime auto lender emerged, followed shortly thereafter by writedowns at regional lenders including Zion’s Bancorp and Western Alliance. JP Morgan Chase’s Jamie Dimon said “I probably shouldn’t say this, but when you see one cockroach, there are probably more,” but the evidence thus far points to an epidemic of loan fraud, not a calamitous end to the credit cycle. Liquidity is still abundant five years after Trump, Biden, and the Federal Reserve threw nearly everything they had at fighting the pandemic’s economic impact, and financial conditions remain astonishingly accommodative.

Sentiment is also improving as the Trump administration shows signs of softening its protectionist policy stance, rhetorically downplaying frictions with China and implementing more tariff carve-outs. Treasury Secretary Scott Bessent and Vice Premier He Lifeng are set to meet this week in Malaysia, and both sides have spent much of the last week engaged in an effort to emphasise areas of common ground. The Wall Street Journal on Friday said that the government is moving toward a more tightly-calibrated tariff regime, with exemptions put in place for hundreds of products that have gained political favour or are not produced in the United States.

The euro is holding firm even after S&P Global downgraded the French credit rating late Friday. According to the unscheduled decision, which saw the nation’s rating lowered to A+ from AA-, “France is experiencing its most severe political instability since the founding of the Fifth Republic in 1958. Even if snap parliamentary elections were to be called and produce a clear majority in the National Assembly, there is no guarantee that this would smooth the path for a credible medium-term fiscal consolidation plan or economic reform implementation”. In theory, this raises the risk that some real-money investors with strict credit quality requirements could be forced to sell the country’s bonds, particularly if the last of the “big three” agencies—Moody’s—were to follow suit. However, the announcement doesn’t come as a shock to traders, who have been bracing for a downgrade for months.

The week ahead will be dominated by the run-up to next week’s decisions from the Bank of Canada, Federal Reserve, European Central Bank, and Bank of Japan.

Friday’s delayed September inflation report from the Bureau of Labor Statistics is likely to pave the way for a second consecutive rate cut from the world’s most powerful central bank. With demand cooling across a range of service-based categories and profit margins coming under strain in goods-producing industries, both core and headline consumer-price measures are expected to ease slightly from August’s levels—adding to signs of labour-market fatigue and tilting the balance of risks toward further monetary easing. Much of this is already reflected in market pricing: Chair Powell and several colleagues have indicated a preference for lower rates, and futures now assign near-certainty to another cut. The market’s response, then, will hinge on whether the data expose upside risks in tariff-affected components.

On the wintry side of the border, today’s quarterly consumer and business outlook surveys from the Bank of Canada could combine with tomorrow’s consumer price index report to help markets calibrate odds on a move at next Wednesday’s meeting. On the inflation side of the equation, expectations are likely to remain well-anchored, and the Bank’s preferred core measures are seen holding steady, even as headline prices firm slightly on a month-over-month basis. But further evidence of weak demand from households and businesses could help clinch the deal for a rate cut, given that policymakers are already deeply concerned about the labour market. In remarks last week, Governor Macklem said “You’ve seen job losses in the heavily-tariffed sectors,” and “In the rest of the economy, you’re really seeing very soft hiring. I think that’s consistent with the fact that firms are feeling the uncertainty”. We think swap-implied odds on a cut—currently near 70 percent—could climb slightly, putting downward pressure on the loonie, all else being equal.

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