Markets Stay on Edge

August 08, 2024

Elias Haddad

Markets Stay on Edge

USD is trading heavy and equity markets are mixed ahead of a data-light day.

RBA Governor Michele Bullock doubles down on the hawkish rhetoric.

New Zealand inflation expectations edged down to the RBNZ 2% target midpoint. Odds of a rate cut next week rise.

USD is trading on the defensive against all major currencies as the money market continues to price-in aggressive Fed funds rate cuts. Fed funds futures are still fully pricing-in 100bps of easing by year-end, and 50% odds of another 25bps cut on top of that.

In our view, the US economy is holding up reasonably well suggesting the Fed is unlikely to slash the funds rate as much as is currently priced-in. The Atlanta Fed's GDPNow model is tracking annualized Q3 growth of 2.9% following real GDP growth of 2.8% in Q2. Moreover, the US job opening rate is steady near pre-pandemic levels at 4.9% and not consistent with a material increase in the unemployment rate.

Nevertheless, a potential repricing in Fed funds rate expectations in favour of USD is unlikely until top line US economic data are released next week. The July CPI and retail sales prints are due next Wednesday and Thursday, respectively. Today, the highlights are the US weekly jobless claims report (1:30pm London) and a fireside chat with Richmond Fed President Thomas Barkin (FOMC voter) (8:00pm London).

Yesterday, ECB Governing Council member Olli Rehn shared his thoughts on the latest market turmoil. Rehn pointed out “it was an overreaction of market forces in the conditions of uncertainty and thin market liquidity during the holiday season, not so much due to issues arising from the fundamentals of the economy.” We agree.

USD/JPY edged down on USD weakness. The key takeaway from the Bank of Japan (BOJ) Summary of Opinions of the July 31 board meeting is that monetary policy is expected to remain accommodative for some time which is a headwind for JPY. Indeed, one BOJ member noted “the level of the neutral rate seems to be at least around 1%.” The BOJ policy rate is at 0.25% and the swaps market implies a policy rate of 0.60% over the next three years.

AUD outperformed after RBA Governor Michele Bullock doubled down on the hawkish rhetoric. Tuesday, the RBA delivered a hawkish hold. Today, Bullock cautioned the board “will not hesitate to raise rates if it needs to”, adding “we don’t see interest rates coming down quickly.” Cash rate futures have fully priced-in a 25bps RBA policy rate cut by year-end. That’s about right in our view.

NZD/USD is struggling to gain upside traction despite broad USD weakness. The sharp decline in New Zealand medium-term inflation expectations towards the RBNZ 2% target midpoint raised the likelihood of a policy rate cut next week and is weighing on NZD. The RBNZ 2-year inflation expectations survey fell to a three-and-half-year low at 2.03% in Q3 from 2.33% in Q2, leading the swaps market to raise odds of an RBNZ August 25bps cut to 75% from 50%.

We still think the RBNZ can afford to wait for October before slashing rates. New Zealand non-tradeable CPI inflation remained sticky in Q2, business confidence picked-up in July and the rise in the unemployment rate in Q2 tracked the RBNZ forecast. As such, NZD/USD has room to edge higher if global financial market risk appetite does not worsen.

USD/CAD continues to edge lower on USD weakness. The Bank of Canada (BOC) July meeting summary of deliberations showed governing council members are particularly concerned with emerging slack in Canada’s labor market. The implication is tomorrow’s Canadian July labor force survey will be a key driver of interest rate expectations. Recall, at the July 24 meeting, the BOC slashed the policy rate 25bps to 4.50% and signaled more cuts are in the pipeline. The swaps market is pricing a total of 150bps of BOC easing in the next 12 months which limits CAD upside momentum.

Reserve Bank of India (RBI) kept the policy rate steady at 6.50%. The decision was widely expected, and INR traded in a tight range. The vote was again 4-2 to keep rates on hold, same as in June. The swaps market is pricing-in 25bps of cuts in the next three months and a follow-up 25bps cut the subsequent three months as India inflation falls towards the mid-point of the RBI’s 2-6% target range.

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