Market Briefing - Markets Go Short Ahead of Long Weekend

- Currency markets are trading on a consolidative footing this morning, with traders suffering from post-traumatic stress syndrome after an exceptionally volatile week. Safe haven assets are in demand and the dollar is slightly higher after yesterday’s risk selloff, when the S&P 500 fell 3.25 percent, and the Nasdaq tumbled 4.08 percent. 

- The Bank of Japan held firm last night, refusing to change short- and long-term rate targets or modify its yield curve control policy. The yen fell almost two percent in the minutes after the decision, but short-term implied volatility levels collapsed, and the exchange rate stabilized just under the 135 mark. 

- The decision was widely expected: Japan is struggling with imported inflation in the form of higher food and energy prices, but consumer demand is weak and wage increases remain restrained. Core price growth is running very close to the central bank’s target. 

- The statement said it was important to “pay due attention to currencies”, and Governor Kuroda changed his tune on the impact of a lower yen, calling it “negative” - but there was nothing to indicate preparation for direct action to support the exchange rate. The Ministry of Finance, Financial Services Agency and Bank of Japan attempted to “jawbone” the currency upward last week, but unilateral intervention efforts are unlikely to succeed in stemming the yen’s longer-term decline. 

- In an interview with a Russian news channel this morning, Russian Deputy Prime Minister Alexander Novak said the European gas market could face “serious issues” this winter if political tensions aren’t resolved. In the last week, the country has cut gas supplies to Italy and France, forcing prices up across the futures curve. This is expected to put additional pressure on the European Central Bank, making a 50-basis point hike at the September meeting more likely. The euro is sitting just above the critically important 1.05 level, vulnerable to a break lower. 

- The Canadian dollar remains sharply lower on the week, with rising oil prices and increased odds on a 75 basis point move at the Bank of Canada’s July meeting providing very little support. From our perspective, rising yields pose a threat to Canada’s debt-laden economy, implying that changes in global risk appetite and financial conditions have become more important than the exchange rate’s more traditional drivers. 

- Before the North American open, Federal Reserve Chair Powell will make opening remarks at an inaugural conference on the dollar’s international role. He is unlikely to deliver new forward guidance, meaning broader market implications should be minimal. 

- May industrial product numbers are due at 9:15. Consensus estimates suggest output decelerated from the previous month’s 1.1 percent gain to 0.4 percent, with the manufacturing sub-gauge slipping from 0.8 percent to 0.3. This would be consistent with other high-frequency economic indicators that are pointing to an incipient slowdown in the world’s biggest economy. 

- Monday is a US holiday, and liquidity levels are likely to fall throughout today’s session as traders cut exposures. This should bring a gradual decline in currency market volatility, but thin volumes could exacerbate any reaction to surprises. 

Have a great weekend!

EVENTS

FRIDAY

USD   Federal Reserve Conference on Dollar's Role

USD  Industrial Production, May

USD   Baker Hughes Weekly Rig Count