Market Briefing - Caution Prevails in Currency Markets as Threat Levels Rise
Foreign exchange markets are treading carefully as European energy prices surge and traders prepare for this afternoon’s Federal Reserve meeting. The dollar index is slipping and ten-year Treasury yields are up slightly as better-than-expected earnings releases from the likes of Alphabet and Microsoft help temper growth fears.
The euro is recovering from yesterday’s fall, but remains weaker on the week as regional gas and power contracts roar to record highs. The benchmark European natural gas contract is at all-time highs and forward electricity curves are trading near record levels as geopolitical tensions and supply disruptions hammer energy markets.
Flows through the Nord Stream pipeline are running at less than 20 percent of capacity after Gazprom warned of maintenance issues with another turbine. European Union countries yesterday reached an agreement to voluntarily cut gas use by 15 percent in the coming months as the region prepares for a complete shutdown in Russian supplies.
Crude prices are advancing. Brent rose almost 1 percent and West Texas Intermediate increased by roughly the same amount overnight, helping the Canadian dollar eke out a modest gain.
Japan’s yen is climbing at an almost-imperceptible pace, supported by narrowing interest differentials and a worsening global growth outlook. Yields on long-term Treasuries are coming down as investors prepare for a recession, reducing the gap against their Japanese equivalents.
Durable goods orders probably slumped in June. Orders for products meant to last for more than three years are thought to have fallen 0.4 percent last month from May as consumers cut spending on big-ticket items and paid higher prices for household essentials.
Traders are well-prepared for a second consecutive 75 basis-point hike this afternoon. Odds on a 100 basis-point move briefly surged past 90 percent earlier in the month, and then fell below 25 percent after a concerted communications effort by voting Federal Open Market Committee members. No new evidence - leaks or economic data points - has come out to bolster the case for a surprise today.
But Jerome Powell’s words could prove market-moving. The Chair’s comments during the post-decision press conference will be carefully scrutinized for guidance on September’s move - and for insight into how policymakers might react to a more pronounced slowdown in the American economy. Overnight index swap pricing currently suggests investors think the Fed-funds rate will climb above 3.25 percent in December, before falling to 2.5 percent by the end of 2023, with central bankers tightening policy sharply before reversing direction. Expectations could shift if Mr. Powell sounds a more aggressive tone on inflation or, conversely, adopts a more dovish stance amid signs of a deepening economic slowdown.
Tomorrow’s gross domestic product report might be more meaningful for politicians than markets. Economists polled by the major data providers think the economy grew at a 0.4 percent annualized rate, after declining at a -1.6 percent pace in the first quarter. A second consecutive contraction is entirely possible, with implications for business and consumer psychology as political narratives grow louder. But most investors are already convinced of an imminent slowdown, and the trade and inventory effects that often dominate headline economic output prints are not critical in driving market behaviour.
Note: Technical difficulties prevented sending yesterday's note. We apologize for the inconvenience.
KARL SCHAMOTTA, CHIEF MARKET STRATEGIST
@KARL_SCHAMOTTA
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