Market Briefing - Risk-Sensitive Currencies Weaken After Bear Market 'Capitulation'

Emerging market and commodity bloc currencies are in retreat and equity futures are setting up for a lower open after yesterday’s neck-snapping market rally. The S&P 500 jumped and the Nasdaq 100 leapt more than 3 percent higher during the North American session after earnings releases beat expectations, convincing traders that a capitulation was at hand. But as recession fears grow once more, the dollar is climbing and ten-year yields are falling as investors seek safety in the world’s deepest and most liquid asset classes.

With rumours swirling around the possibility of a 50 basis-point interest rate increase at tomorrow’s European Central Bank meeting, the euro climbed yesterday, but is now losing altitude. Earlier this morning, Russian President Vladimir Putin threatened to curb gas shipments through the Nord Stream 1 pipeline if a second turbine - which had been stuck in Canada - wasn’t returned promptly, and a number of European officials suggested that the bloc was preparing for a winter without Russian supplies. The European Commission put forward a plan to ration consumption and force member countries to adopt supply cuts in the coming months. Commission President, Ursula von der Leyen, said, “Russia is blackmailing us. Russia is using energy as a weapon.”

Italian yields are falling after Prime Minister Mario Draghi said his coalition government could be rebuilt after last week’s confidence vote, suggesting in a speech before the Senate that he was willing to remain in power if parliamentary support was in place. Mr. Draghi is expected to speak again later today, and a reversal in sentiment is possible if the key parties continue to rebel against his leadership.

Implied volatility levels on the euro remain elevated, particularly on shorter tenors.

Inflation hit a 40-year high in the United Kingdom last month, with prices rising 9.4 percent in the year to June as food and energy costs climbed. After Governor Andrew Bailey said a jumbo-sized move was “on the table”, the Bank of England is widely expected to respond with a 50 basis-point rate hike when it next meets in early August. The pound has lost some momentum, but is up roughly 0.75 percent on the week.

Canada is expected to follow with an 8.4 percent print this morning, helping to justify last week’s shockingly-large 100 basis-point interest rate hike. But the monetary policy implications are limited and market reaction should be somewhat muted: the Bank of Canada meets again in September, meaning that policymakers will be looking at the July inflation report - one that is likely to show a drop in gasoline prices - when making the next rate decision.

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