A Softer Dollar Remains the Way to Go

Market Commentary

Markets

Last week’s directional moves on key markets were extended yesterday in absence of any guidance coming from eco data or central bankers. Core bond yields fail to recover from the early August setback with daily changes in the US ranging between -1.8 bps (30-yr) and +1.6 bps (2-yr). German yields closed almost unchanged. Especially US money markets keep banking on significant Fed rate cuts to come. Apart from the magnitude of the lift-off (25 bps being our preferred scenario), especially the 2025 path will be challenged in the updated September FOMC dot plot. Markets currently discount a 3.25% policy rate by the end of 2025 compared with a median Fed view of 4%-4.25% back in June. Aggressive rate cut bets keep the dollar in the defensive. EUR/USD yesterday closed at its best level YTD (1.1085 from 1.1014) with resistance levels lining up: 1.1139 (December top) and 1.1276 (2023 top). A softer dollar remains the way to go. The less restrictive monetary policy where money markets are hoping for should help accommodate the US soft landing and especially rule out the downside recession risk. It’s what helped US stock markets stage an impressive comeback since the August 5 market meltdown. Key benchmarks yesterday rallied another 0.6% (Dow) to 1.4% (Nasdaq), lifting them to this month’s best levels. On commodity markets, gold closed at an all-time high of $2548.3/ounce. Brent crude remains under selling pressure ($77/b) both because of global demand concerns and as the US indicated that Israel accepted a cease-fire proposal in Gaza.

Asian stock markets join yesterday’s positive momentum with China underperforming. Chinese banks kept their benchmark lending rates unchanged (1y: 3.35% & 5y: 3.85%) after cutting them by 10 bps each only a month ago. ECB governing council member Rehn said that the recent increase in negative EMU growth risks reinforced the case for a September policy rate cut (provided that disinflation remains on track). He sees no clear signs of a pick-up in the manufacturing sector even though the energy cost drivers seem to have largely faded away. Today’s eco calendar remains extremely thin with only final July EMU CPI data on tap. The Swedish Riksbank is expected to lower its policy rate for a 2nd time by 25 bps (to 3.5%) with the Turkish central bank forecast to hold rates steady at 50%.

News & Views

The NY Fed’s SCE labour market survey showed a mixed picture. It recorded a sharp increase in the proportion of job seekers compared to a year ago. Among those employed four months ago, 88% were still with the same employer, a low since the start of the series in July2014 as the transition rate rose sharply. Looking forward, the expected likelihood of moving to a new employer increased to 11.6% from 10.6% in July 2023. At the same time, the average expected likelihood of becoming unemployed rose to 4.4% from 3.9% also a new high. Satisfaction with wage compensation as well as with nonwage benefits and promotion opportunities all deteriorated. Conditional on expecting an offer, the average expected annual salary of job offers in the next four months declined to $65,272 from $67,416, though it remains significantly higher than pre-pandemic levels. The average reservation wage—the lowest wage respondents would be willing to accept for a new job—increased to $81,147 from $78,645. The average expected likelihood of working beyond age 62 increased to 48.3% from 47.7. The average expected likelihood of working beyond age 67 increased to 34.2% from 32.

The Minutes of the 5-6 August meeting of the Reserve bank of Australia showed that the central bank discussed a further rate hike, but concluded that the stronger case was for leaving the policy rate unchanged at 4.35%. Members noted that developments over preceding months supported the view that inflation would be slow to decline. Underlying inflation had fallen very little over the prior year in quarterly terms and inflation was still some way above target. Members also saw the gap between aggregate demand and supply being somewhat larger than previously assessed. Holding the cash rate target steady at its current level for a longer period than currently implied by market pricing may be sufficient to return inflation to target in a reasonable timeframe. The Board will need to reassess this at future meetings. Still it guided that it was not possible to either rule in or rule out future changes in the cash rate target.

Graphs

GE 10y yield

The ECB cut policy rates by 25 bps in June. Stubborn inflation (core, services) make follow-up moves less evident. Markets nevertheless price in two to three more cuts for 2024 as disappointing US and unconvincing EMU activity data rolled in, dragging the long end of the curve down. The move accelerated during the early August market meltdown.

US 10y yield

The Fed in its July meeting paved the way for a first cut in September. It turned attentive to risks to the both sides of its dual mandate as the economy is continuing to move better in to balance. Money markets tend to err in favour of a 50 bps lift-off. The pivot weakened the technical picture in US yields with another batch of weak eco data pushing the 10-yr sub 4%.

EUR/USD

EUR/USD moved above the 1.09 resistance area as the dollar lost interest rate support at stealth pace. US recession risks and bets on fast and large (50 bps) rate cuts trumped traditional safe haven flows into USD. EUR/USD 1.1139 (Dec 2023 high) and 1.1276 (2023 top) serve as next technical references.

EUR/GBP

The BoE delivered a hawkish cut in August. Policy restrictiveness will be further unwound gradually 0on a pace determined by a broad range of data. The strategy similar to the ECB’s balances out EUR/GBP in a monetary perspective. Risk-off proved a more important driver of GBP recently, triggering a return from 0.84 towards 0.86.