Market Brief: Currency Markets Enter Holding Pattern

Financial markets are in calm-before-the-storm mode ahead of a raft of economic data releases that are expected to show the US economy outperforming its advanced-economy peers, and before Americans head to the polls to choose the next president. The dollar is holding recent gains, Treasury yields are down slightly, equity futures are little changed, and oil prices are steadying after yesterday’s steep descent. The pound is trading sideways ahead of tomorrow’s Autumn Budget, and deteriorating cross-Atlantic rate differentials are keeping pressure on the euro.

The Canadian dollar remains firmly on the defensive, pressured by weak domestic fundamentals, widening yield spreads, and fears surrounding next week’s US election. Odds on another half-percentage-point move at the Bank of Canada’s December meeting are back up to coin-toss levels after Governor Tiff Macklem yesterday told The Logic’s Kevin Carmichael “It makes sense to take some bigger-than-normal steps when you’ve taken some really big steps on the way up,” and forward differentials - which measure the difference between Canadian and US interest rates, but not directional views on exchange rate outcomes - have widened out to levels not seen since the turn of the century. On Friday, Macklem said “If you look back over history, interest rates in Canada and the US can differ. There are limits to how big that difference can be. But we’re not close to those limits and those limits are not factoring into our current policy decisions.”

Both the Canadian dollar and the Mexican peso are expected to come under severe selling pressure if Donald Trump emerges victorious on Monday. This is partly based on the reaction to the upset in 2016 - when the dollar surprised most observers by rallying in the days following the vote - and on each economy’s extraordinarily-high dependence on US export markets. We think this could prove too simplistic - Trump’s impact on the American economy and its trading partners might be far more complex than is currently appreciated - but market participants are nonetheless likely to keep increasing hedges against this outcome in the days to come, keeping risks in both currencies tilted to the downside.

Japan’s yen is holding near a three-month low, struggling to make headway after the weekend’s disastrous electoral result for the Liberal Democratic Party set the stage for a political compromise that could erode support for the Bank of Japan’s tightening plans. The central bank is expected to keep its policy rate unchanged at its meeting later this week, and Governor Kazuo Ueda’s words in the post-decision press conference will be closely examined for evidence of increased uncertainty, but the impact on markets should be minimal. Carry traders - speculators who borrow in low-yielding currencies and invest in higher-yielding units elsewhere - are tiptoeing back into yen-funded plays, but remain cautious ahead of Friday’s non-farm payrolls report and the US election. We expect flows to pick up once those event risks are firmly in the rear-view mirror.

This morning’s September Job Openings and Labor Turnover could help ease the relentless upward pressure on the greenback. The number of jobs available in the US economy is seen slipping slightly relative to August, corresponding to a three-year low in the number of vacant positions at small businesses, as measured by the National Federation for Independent Business’ Unfilled Job Openings Index. The print may be distorted by the ongoing Boeing strike and Hurricane Helene’s impact, but hiring should continue to slow, layoffs might tick up, and the quits rate - reflective of underlying confidence in labour market prospects - could hold at 1.9 percent, down from a peak of 3.0 percent in early 2022.

The Conference Board’s consumer confidence index is expected to show modest signs of recovery in October after posting the biggest decline in almost three years last month - but household survey results should, perhaps more than ever, be taken with a big grain of salt. As The Economist magazine explored in this article last year, the gap between consumer beliefs and the actual state of the economy has widened out to spectacular levels in recent years - and other research has shown that political partisanship is playing an enormous role in the deepening contrast between what people say they will do, and what they actually do. The Conference Board measure queries a larger number of people, and tends to run higher than its University of Michigan equivalent, but is also likely to be heavily influenced by the deluge of negative news that has hit in the run-up to next week’s presidential election.

Tomorrow’s third-quarter gross domestic product report should provide a more realistic view of underlying fundamentals, but again, could contain elements of a front-running effect as businesses stockpiled inventories ahead of last month’s port strike and next year’s expected increase in trade tensions. Economists think the economy expanded at a 3-percent annualised pace in the three months ended in September, with rising consumer spending doing most of the heavy lifting, assisted by elevated levels of inventory accumulation and a steady increase in business investment in capital goods that could be hit by tariffs early in 2025. Most observers expect this to slow in the coming months - especially if retailers can begin destocking - but downturn odds should remain very low for now, despite the fact that 3 out 5 Americans are mistakenly convinced that the economy is currently in recession.

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