Central banks are diverging on monetary policy, but the trend of lower yields persists. The Federal Reserve left policy rates unchanged, the Bank of Japan raised interest rates for a second time while the Bank of England started its easing cycle.
Lower bond yields are not seen as automatically risk positive as they are driven by weaker growth instead of disinflation. Bad data is not good data anymore. Markets have already positioned for lower yields as recession risks are on the rise.
The 10-year Treasury yield fell below the 4% mark for the first time since early February, while the 2-year dropped below 4.2%. The Nasdaq and S&P 500 recorded a third week of declines with the former recording an 8.9% overall drawdown.
Politics continues to matter. In the United States, Kamal Harris has caught up with former President Donald Trump when it comes to betting odds. On the geopolitical front, attacks from Israel deep into Iran have caused oil prices to push higher.
The Japanese yen traded higher against the US dollar for a fourth week in a row as USD/JPY extended its drawdown to 8.8%. June has been the weakest month for the currency pair so far this year and July just continued this momentum.
The dollar was unchanged until Friday but was hit heavily by the downside surprise of US job growth coming in at just 114k as the unemployment rate rose to 4.3%.
Next week has only a few risk events including the ISM services PMI, bank lending survey and European sentiment indicators.
Global Macro
Fed gains vanish as outlook darkens
Easier policy ahead. Global markets had a significant dovish bias going into
Wednesday’s FOMC meeting and Jerome Powell did little to nothing to dispel the expectations of lower interest rates ahead. The policy rate remained unchanged at 5.25% – 5.50% as expected. However, putting rate cuts on the table for September and acknowledging the recent cooling of the labor market have been enough for investors to commit to pricing in easer policy. The Nasdaq index pushed higher by more than 2.5% and the Brent crude oil price soared 3.5% on Wednesday. Markets are now anticipating the Federal Reserve to cut interest rates five consecutive times starting in September, leaving the Fed funds rate at 4.00% – 4.25% in March 2025.
Happy for a day. However, the Fed’s willingness to consider easing interest rates at its next meeting only helped riskier assets for a single day, as investors began to wonder if policy makers have already waited too long. Macro data sent some strong signals of a cooling labor market and manufacturing sector this week. Markets have embraced the expected beginning of the easing cycle amid weaker growth.
Macro driven risk-off mood. The 10-year and 2-year Treasury yield fell below the 4% mark for the first time since early February. Bad data has stopped being interpreted as risk-positive due to weaker growth driving yields lower, not the disinflation story. Stock markets around the world lost their Fed induced gains from Wednesday. All three US equity benchmarks dropped by more than 1.5% on Thursday and the Nasdaq and S&P 500 recorded a third consecutive week of declines. Stocks extended the fall on Friday after a horrible nonfarm payrolls report increased recession fears.
Yen troubles markets. The Japanese yen traded higher against the US dollar for a fourth week in a row as USD/JPY extended its drawdown to 8.8%. June has been the weakest month for the currency pair so far this year and July just continued this momentum. This is adding to the global red of sea in Japanese and global equity markets and the overall risk off environment coming from rising risks on the geopolitical (Middle East) and US politics (rising Harris bets) front. This also comes at a time that is seasonally weak for equities as liquidity dries up in summer.
Regional outlook: Eurozone
Data throws ECB a curveball
Inflation edges up. The annual inflation rate in the Eurozone unexpectedly accelerated to 2.6% in July, led by higher energy prices. The outlook diverged at a regional level where prices rose faster in Germany, France, and Italy but eased in Spain. The core rate that excludes prices of food, energy, alcohol and tobacco, held steady at 2.9%, compared to expectations of 2.8%, while services inflation eased to 4% (-0.1ppts) for the first time in three months. Such numbers throw the ECB a curveball after it paused policy loosening in July to await more evidence on the strength of price pressures. While investors anticipate a cut in borrowing costs in September (24bps priced into the OIS curve), officials have stressed their decision will hinge on a number of indicators still to come.
Q2 growth exceeds expectations… The Eurozone economy expanded at a faster-than- expected 0.3% in Q2, according to preliminary figures, led by growth in France, Italy, and Spain. Meanwhile, Germany unexpectedly contracted by 0.1% quarter-on-quarter, compared to forecasts of a 0.1% gain. There was a notable decline in investments in equipment and buildings, as the industrial sector continues to be particularly strained by high interest rates.
… but look under the hood. Despite a Q2 expansion, French household consumption fell 0.5% MoM. The number of unemployed people in Germany increased for the 19th consecutive period. Coupled with increase in insolvencies and declining recruitment plans in both manufacturing and services point to further challenges in the coming months. Eurozone unemployed unexpectedly rose to 6.5%. Moreover, the latest EZ survey data, namely Ifo, ZEW, Sentix and composite PMIs have all plateaued in June and weakened sharply in July.
Week ahead
Lingering uncertainty
Lingering uncertainty. The sea of red in global equity markets and strength of the Japanese yen are likely to intensify the upcoming macro week and will up the ante for central bankers looking to engineer a soft landing. Investors will need some time to
digest the plethora of this week’s data releases and rate decisions. The upcoming week lacks real risk events apart from the ISM services PMI report and SLOOS survey in the United States, which are both due to be published on Monday. This means that the risk negative flows caused by the weakening of macro data could linger around for some time and that minor second tier data will get special attention going forward.
Only two sets of data. The Fed’s Senior Officer Opinion Survey (SLOOS) is expected to show a continued rise in lending restrictions from US banks. The earnings season provided some insights into banks provisioning more for losses than anticipated as a sign of some preparation for worst days ahead. The services sector, however, could show some improvement on a month-on-month basis in July. The barometer from the ISM currently sits in negative (below 50) territory for both the manufacturing and services sector. Attention will also fall on the most important sub-indicator of the survey, namely employment.
Canadian jobs. Staying in North America, investors will focus on the Canadian employment report. June had been a weak month showing negative job growth. July should be different but won’t deter the overall cooling of the labor market. This means that rate cuts this year not only remain on the table but are seen as the base case.
European surveys. European data on the other hand will include final PMI’s, Sentix
Investor Confidence, German factory orders and European retail sales.
FX Views
FX markets in the yen’s chokehold
USD Gravity pulling on the dollar. The strength of the Japanese yen, its high weighting in the DXY basket and the range bound movement of the US dollar all mean that no clear trend has been visible when it comes to the Greenback. The currency has lost about half of its year-to-date gains in July but remains in positive territory against most of its peers in 2024. Still, some of the favorable factors that have supported the dollar during the first half of the year are starting to fade. Its exceptional growth and high yielding status have continued to weaken with only the safe-haven flows from geopolitical risks supporting the Greenback. Political uncertainty surrounding the US election could keep it that way and the uptick in inflation means that the likelihood of investors pricing in too aggressive policy easing remains alive. DXY dropped below the 104-mark following the US job report showing hiring only increased by 114k as the unemployment rate rose to 4.3%. The attention is now on individual currency pairs, most notably USD/JPY on the DM and USD/MXN on the EM side.
EUR Saved by US founder. The Euro index declined 0.5% WoW amid sizable losses against safe-haven currencies, especially JPY and CHF. EUR/JPY experienced its worst monthly decline in eight years (-5.8%), while EUR/GBP fell for the fifth consecutive month in July, marking the worst streak since January 2020, amid UK outperformance and uncertainty over the August BoE decision. European front-end rates continue to lag recent growth news, both domestic and external. Even though the ECB’s focus remains on inflation, any shift towards recognising growth risks will likely result in euro depreciation. Signs of this shift began to appear in the second half of July; Despite posting a second monthly gain of the year, EUR/USD momentum rapidly waned by the end of the week. Spot briefly plunged to a near 1-month low of $1.078, before regaining the losses on the back of abysmal US NFPs print.
GBP BoE joins the party. The British pound fell versus all G10 peers over the last week with the largest losses versus the low-yielding safe-haven currencies like the Japanese yen and Swiss franc. The GBP was pressured after the Bank of England cut interest rates by 25bps to 5.00% – the first rate cut since the pandemic as the BoE joined other major central banks like the ECB and BoC in loosening policy. The decision was tight, with a 5-4 split in the voting committee, and Governor Andrew Bailey was reluctant to provide guidance on the future path of policy. The GBP was also hit by risk-off selling as US equities fell on slowing economic data and poor June-quarter earnings especially from large tech firms like Amazon and Intel. GBP/USD has now clearly rejected the 12-month highs at $1.3000 and has moved into a short-term downtrend with initial downside targets to the 200-day EMA at $1.2660. Topside targets for the week ahead are to $1.2830. Looking forward, the data calendar is light, with construction PMI on Tuesday the highlight.
CHF Safe-haven appeal. The Swiss franc has been a clear outperformer over the last four weeks as its safe-haven appeal drives gains as global equities fall. CHF gained versus all other G10 currencies over the week with the exception of the dominant Japanese yen. July’s headline annual inflation was reported at 1.3% and the headline annual rate has been below 1.4% for all of 2024. This should allow the Swiss National Bank to cut rates further with market pricing seeing a more-than 90% chance of a 25bps cut when the SNB next meets on 26 September. USD/CHF and EUR/CHF both fell to six- month lows over the week and, while some momentum indicators like the RSI have moved into oversold territory, these momentum indicators have not yet signaled a reversal, although a reversal might be nearing. On USD/CHF, topside targets are to 0.8795, while topside targets on EUR/CHF are to 0.9520. Looking forward, unemployment and retail sales are due Tuesday.
CNY China’s economic slowdown: Manufacturing sector struggles persist. China’s July manufacturing PMI remained in contraction at 49.4, slightly below the previous month’s figure. New orders further declined to 49.3, while new export orders showed a marginal improvement. The non-manufacturing PMI softened to 50.2, with the composite PMI also declining. These figures highlight the ongoing challenges in China’s economy. Despite the weak data, the July Politburo meeting focused on better implementation of existing policies rather than introducing new stimulus measures. USDCNH is now at 7.2128, at the key support level of 200-day EMA moving average. In the coming week, traders should monitor key economic indicators, including Caixin Services PMI, trade balance, CPI, and PPI, for a more comprehensive view of China’s economic health.
JPY Bank of Japan’s balancing act: Policy shifts amid political pressures. BoJ Governor Ueda’s recent press conference sidestepped questions about political pressure on the central bank to hike interest rates. This comes amid the upcoming leadership race for Japan’s ruling Liberal Democratic Party in September, coinciding with the next BoJ meeting. Some politicians have called for policy tightening to support the yen, raising speculation about political influence on recent policy decisions. USD/JPY experienced significant volatility around the BoJ decision, trading from 152.70 down to 151.58, then up to 153.96 before settling in the 152.50-153.00 zone. After Ueda’s press conference, which maintained a hawkish tone, the pair tumbled to 150.05 and has struggled to reclaim the 151 mark since. The 150.00 level serves as key psychological resistance. Upcoming economic releases, including BoJ meeting minutes and household spending data, could provide further insights into Japan’s economic trajectory.
CAD Bears continue to dominate. The Canadian dollar bounced back from an eight- month low of C$1.389, bolstered by dollar weakness and a rebound in oil prices. Investors digested the latest GDP data, indicating the Canadian economy grew 0.1% in June, continuing the deceleration seen in recent months. The Loonie’s direction continues to be largely dictated by external developments, including geopolitical tensions and Wednesday’s FOMC decision. A significant rebound in oil prices, Canada’s largest export, amid rising supply concerns, contributed to increased foreign currency inflows. Additionally, a marginal narrowing of the OIS implied US-CA yield spread for the December 2024 cushioned the Canadian dollar from further losses. One-month USD/CAD realised volatility fell to a fresh four-year low of 3.63%, while the spot appreciated by a 0.3% week-on-week. Loonie’s net positions extended to the lowest level since December 2001 on July 23, while total shorts brushed an all-time high. Given the crowded positioning, we maintain that there is limited room for further USD/CAD gains.
AUD Australia’s inflation puzzle: CPI data sparks market reaction. Australia’s Q2 headline CPI came in at 3.8% y/y, aligning with the RBA’s view but above the median consensus forecast. The trimmed mean was 3.9% y/y, slightly above RBA expectations. This data may boost confidence among RBA policymakers in their ability to cool prices while preserving job gains. The RBA’s stance differs from other major central banks, as it hasn’t ruled out rate hikes. Market focus now shifts to the timing of potential rate cuts, with OIS markets eyeing December. AUD/USD experienced a significant whipsaw, retreating into its former 2024 trading range and retracing two-thirds (at the time of writing) of its Apr-Jul advance. This movement mirrored the initial risk-off sentiment in global markets. Investors should watch the upcoming RBA rate decision for further insights into monetary policy direction.
