Market Briefing - Yields Fall and Dollar Rises as Traders Monitor Gathering Storm Clouds

The dollar is cutting its losses this morning, climbing against most of its major counterparts as recessionary narratives reassert themselves. On a trade-weighted basis, the greenback ticked 0.2 percent higher overnight, leaving it down roughly 0.9 percent in the last five days. Treasury yields are falling, with investors increasingly convinced next week’s 75 basis-point rate hike will mark a peak in this tightening cycle.

Jobless claims rose last week, suggesting that signs of labour market softness are beginning to appear. Data released yesterday showed the four-week moving average, which smooths out volatility, rising to 240,050 - far below historical levels, but the highest since late last year as employers seemed to turn more cautious.

The euro is back on the defensive. The common currency leapt more than a cent against the dollar after policymakers tightened policy by more than expected yesterday morning, but then began falling as traders bet that the deeply-political and ambiguous language surrounding the central bank’s new spread-compression tool meant it was unlikely to ever find meaningful use on the front lines. The spread between Italian government bonds and their German equivalents is holding near 230 basis points, reflecting a sharp rise in default risk.

Signs of a European slowdown are mounting after widely-watched manufacturing and composite purchasing manager indices fell into contractionary territory earlier this month. Euro area surveys performed by S&P Global dropped by more than expected in July, dropping below the 50 threshold that signals an expected downturn. The European Central Bank’s record of raising rates into a recession looks likely to remain unbroken.

Japan remains a global outlier. Data released last night showed headline prices rising 2.4 percent year-over-year in June, down from 2.5 percent in May. Core inflation - which in Japan includes fuel but not fresh food - increased slightly to 2.2 percent from 2.1 percent in the prior month. This is slightly above the Bank of Japan’s target, but suggests disinflationary forces remain deeply entrenched in the economy.

North American oil prices are edging down as the demand outlook softens. Data out earlier in the week showed US gasoline inventories are rising on a drop in consumption during the mid-summer driving season, while renewed lockdowns in China, a recovery in Libyan production, and a lack of speculative interest weigh on benchmark prices and refining margins. West Texas Intermediate is trading for $94.50 a barrel, just a few dollars away from levels reached prior to Russia’s invasion of Ukraine.

Gasoline prices likely lifted Canadian retail receipts in May. Headline sales are expected to rise 1.6 percent, up from the 0.9 expansion recorded by Statistics Canada in April, with the core measure moving in close alignment as vehicle purchases remained stable. Economists think a preliminary estimate for June will show continued strength, but we think the drop in gasoline prices in the month could exert some downward drag. As noted yesterday, correlations between the Canadian dollar and oil prices have risen sharply in the last month, meaning that currency traders are likely to look through this morning’s data as they focus on developments in the commodity markets.

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