Trendless markets as investors seek new drivers
More than a week after the FOMC lifted borrowing costs in the US, financial markets – particularly the equity market – have been treading water as investors struggle to find a new driver. Both the Euro STOXX 50 and S&P 500 are about to close the week flat. In the bond market, the picture is quite similar as US treasury yields erased last week’s gains, which were made on the back of a surprisingly hawkish Fed statement. Only the pound sterling, which is subject to a lot of uncertainty due to the Brexit situation, has created some excitement. This morning, GBP/USD extended gains as it returned to 1.2735; however on the longer-term it continues to trade within its monthly downtrend channel.
After a very light week in terms of economic data, the US dollar has started Friday on the backfoot with the dollar index falling 0.30%. A bunch of soft economic indicators are due for release later today – manufacturing, services and composite PMIs – but we believe investors won’t pay much attention to those as they are looking for longer term drivers.
For now, investors do not expect a Fed interest rate hike in September but leave the door wide open for December. On the political side, the President Trump impeachment story is losing momentum. Against this backdrop, the yellow metal initiated a small rally as it rose to $1256 from $1240. Should this trendless situation remain, gold should have legs to extend gains.
Canadian inflation in spotlight
Markets have completely priced in a 25bp rate hike by the Bank of Canada by the end of 2017 leaving room for economic disappointment. We believe it’s too early for the BoC to be thinking about higher rates. With front-end yields at the near term high, we doubt that CAD will have much more upside. In the longer term, the weakness and sustained negative outlook for oil prices will likely drag Canadian growth and pressure inflation dynamics.
It was BoC Governor Poloz speech which included a hawkish signal shift that drove policy tightening expectations. Yet commodity weakness will force members to easy back on arguments for normalisation. While uncertainty over US economic policy and NAFTA renegotiations will linger, markets will be focused on today’s Canadian inflation data for May.
While this read fails to take into account crude sharp drops, it should help steer expectations. We suspect risks are asymmetrical, with significant downside should CPI disappoint and traders fade BoC hawkishness. Annual Core CPI is expected to come in at 1.4% from 1.3%. Although market sentiment on USDCAD is bearish, we remain constructive on pair.
