Market Briefing - Markets Turn Doubtful on Slowing Growth, Peak Inflation Narrative, Dollar Weakens

“If there is one thing we know about the sentiments of crowds, it is that they change,” wrote the authors of Mobs, Messiahs, and Markets, “Today it is greed. Tomorrow it is fear. But rarely is it doubt”.

Today, however, markets are doubting themselves.

Recession worries are fading and inflation expectations are reverting higher after yesterday’s May job openings data and a services sector survey came in better than expected. Investors are lifting odds on a 75 basis point move at the Federal Reserve’s next decision after minutes from the central bank’s last meeting showed policymakers were willing to take rates into “restrictive” territory. After climbing to a new two-decade high yesterday, the dollar is slumping as money flows into cyclically-exposed commodity currencies rebound. Implied volatility in bond and currency markets is moving higher, with several measures touching levels last seen when pandemic fears peaked in early 2020.

Perfidious Albion is staying on-brand, with Prime Minister Boris Johnson stepping down a few minutes ago, bowing to reality after more than 50 members of his government resigned. The pound climbed slightly on the news, as tax cuts are likely to figure prominently in the campaign to replace him.

After falling through the 1.02 threshold against the dollar for the first time in two decades, the euro is sliding sideways - but traders are on high alert for a non-linear move to the downside. The European growth outlook continues to worsen as tensions with Russia drive energy prices higher, and few expect the European Central Bank to keep pace with the Federal Reserve’s tightening trajectory in the months ahead.

Momentum is building for a break through parity, with options markets now putting the odds at better than coin-toss levels. Such a move might open up even more downside - currency markets have a tendency to become psychologically unanchored when a big round number is breached - meaning that a drop to 0.95 or lower is not outside the realm of possibility in the near term.

Front-month crude oil prices are flirting with the $100 mark, with bulls smarting after Tuesday’s remarkably-violent selloff. Global demand forecasts have ratcheted slightly lower this week, but supply levels remain constrained and inventories are very tight. A detente between the United States and Saudi Arabia is hardly a done deal. An upward move cannot be ruled out.

The Canadian dollar is catching a slight bid, climbing as the greenback weakens and implied volatility falls. Investors still expect the Bank of Canada to tighten more aggressively than the Fed, with two-year Canadian bonds paying 14 basis points more than their US counterparts, while ten-years trade at a 26-point premium.

Jobless claims for the week ended July 2 are seen falling to 230,000 from 231,000 in the week prior.

The US trade deficit could narrow slightly from April’s 87.08 billion in May, but will remain extremely elevated as consumer spending continues to outpace exports to the world.

Tomorrow’s non-farm payrolls report remains the week’s main attraction, but isn’t likely to materially sway positioning ahead of the Fed’s meeting at the end of the month. Markets are overwhelmingly convinced a 75 basis point move is coming, and we think officials likely to pause before reassessing monetary direction in late August or September - when more data is in hand.

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