Market Briefing - Dollar Pushes Higher on Rising Fed Expectations

The dollar is crushing every major currency in its path as it moves toward 20-year highs in the aftermath of yesterday’s shockingly-high June inflation number. Evidence of a continued acceleration in prices, coupled with a broadening in core pressures have heightened expectations for a more aggressive response from the Federal Reserve in the near term - while also raising the likelihood of an economic downturn further out.

Odds on a 100 basis point move at the July meeting are floating above the 80 percent mark after several officials acknowledged the possibility of a larger hike. Treasury yields are climbing, with shorter maturities rising more sharply and the inversion between two-year and ten-year yields — often considered a recession indicator — falling to its deepest depths since 2000.

This has led to an unusual situation in which funds are flowing into the United States for yield-seeking and safe-haven reasons - a combination which is taking a devastating toll on major and exotic currencies across the foreign exchange markets.

Oil prices fell further overnight, with barrels of West Texas Intermediate going for $94, and Brent for $96. The two benchmarks are down 11 and 15 percent respectively on the month - but remain 25 percent higher this year.

Canada’s loonie is plunging lower, seemingly ignoring yesterday’s surprise 100 basis-point hike from the Bank of Canada. We suspect that the Canadian move mostly served to anchor US expectations higher, while also threatening the country’s highly-leveraged household sector with a tightening in domestic and international financial conditions - a one-two punch that could derail consumer consumption and weigh on growth.

The Japanese yen is knocking on the 140 mark on a widening in yield differentials, with safe-haven flows directed firmly in the dollar’s direction.

The euro is on the defensive, holding just above parity after the Five Star party said it would abstain during a confidence vote, threatening to destabilize Italy's ruling coalition government. Prime Minister Mario Draghi has threatened to quit if the vote goes against him, widening the yield spread between ten-year German and Italian bonds to 209 basis points.

Next week will bring two critical event risks on the same day - the European Central Bank will meet and the Nordstream 1 pipeline is scheduled to reopen after annual maintenance on Thursday. One-week implied volatility in option markets has risen dramatically, suggesting that demand for hedges is surging - on both sides of the pair.

Another modest increase in weekly jobless claims is expected today, but the labour market remains remarkably tight, with no evidence of a slowdown in hiring yet in sight.

Producer prices will be released at 8:30, offering insight into whether businesses continue to pass along higher input costs to retailers and consumers. Economists are anticipating a 0.8 percent rise in June from May.

Tomorrow will bring June retail sales and two critical measures of price psychology: a monthly consumer sentiment survey from the University of Michigan and the Fed’s quarterly index of common inflation expectations. Evidence of an “unanchoring” could see odds on a jumbo-sized hike - and on a policy-driven recession - ratchet higher still.

Upcoming Events

THURSDAY

USD    Weekly Jobless Claims

CNY    Gross Domestic Product, Q2

FRIDAY

USD    Retail Sales, June

CAD    Existing Home Sales, June

USD    University of Michigan Consumer Sentiment

USD    Baker Hughes Weekly Rig Count