Market Brief: Easing Expectations Fall, Markets Retreat
The dollar is still making the weather in global financial markets this morning, heading for a circa 1.5-percent weekly gain, even as it weakens slightly on a modest softening in overall risk sentiment. Treasury yields are holding at elevated levels as investors ratchet rate cutting expectations lower, and equity futures are pointing toward another weak session as uncertainty grows around the economy’s potential performance under a second Trump administration.
Expectations for the Federal Reserve’s easing trajectory are pulling back after two influential officials said the central bank could take its time in cutting rates. In a speech given to business leaders in Dallas, Chair Jerome Powell said “The economy is not sending any signals that we need to be in a hurry to lower rates. The strength we are currently seeing in the economy gives us the ability to approach our decisions carefully”. “The recent performance of our economy has been remarkably good, by far the best of any major economy in the world,” he said, the labour market is “now by many metrics back to more normal levels that are consistent with our employment mandate,” and "Inflation is running much closer to our 2 percent longer-run goal, but it is not there yet”. Susan Collins, president of the Boston Fed, echoed his comments in an interview with the Wall Street Journal, saying that a move next month is “certainly on the table, but it’s not a done deal … There’s more data that we will see between now and December, and we’ll have to continue to weigh what makes sense.”
Trade war risks are adding to the dollar’s underlying momentum. A series of dramatic reassessments of the Fed’s expected easing trajectory - quantified using the Fed fund futures curve in the chart below - provided much of the motive force for the currency’s movements over the last year, but it is clear that something changed just after the election, helping deliver outsized gains relative to underlying rate expectations. We think this could continue for a few weeks yet as traders try to front-run the mechanical exchange rate adjustments that economic theory suggests is inevitable during the application of tariffs, but suspect that the ‘Trump trade’ will eventually collapse under its own contradictions, setting foreign exchange markets up for a reversal.
Ahead today, traders are waiting for a retail sales number to confirm continued resilience in US consumer spending, and for comments from Fed officials including Collins, Williams, Goolsbee, and Barkin.
The data calendar looks relatively quiet through to Tuesday’s Canadian inflation print, which is expected to show a gasoline-powered uptick in headline consumer prices. The Bank of Canada’s preferred measures of core inflation should remain well below target - particularly once shelter costs are excluded. Markets are still putting coin-toss odds on a half-percentage-point move at the Bank’s December meeting, and we’re inclined to think this is too high, given the major uncertainties that the economy is facing in the months ahead. With housing markets showing signs of recovering, wage growth accelerating, financial conditions easing, US consumer demand going from strength to strength, and trade policy set to evolve in an unknown direction, the range of possible economic outcomes is large. A quarter point cut seems more plausible.
The UK economy decelerated unexpectedly in the three months to September, putting pressure on the Bank of England to cut rates more aggressively. Gross domestic product grew just 0.1 percent in the third quarter - shrinking -0.1 percent in September alone - after expanding at the fastest clip in the Group of Seven during the first half of the year. We think the economy could show signs of stabilisation if the government’s recently-announced fiscal spending efforts bear fruit over the next year, but overall uncertainty levels - exacerbated by developments in the United States - might weigh on business investment and consumer sentiment to a greater degree, necessitating an accelerated course of rate cuts. The pound, which is now effectively flat against the dollar after a remarkable period of outperformance earlier in the year, could struggle to break back above the 1.30 threshold in the absence of an improvement in the global sentiment backdrop.
In Mexico, central bankers are turning more dovish. Policymakers at the Banxico cut rates by a quarter point in yesterday’s decision, and the accompanying statement was fairly non-committal, saying “Looking ahead, the Board expects that the inflationary environment will allow further reference rate adjustments. It will consider the prospects of global shocks continuing to fade and the effects of the weakness in economic activity,” - but the decision itself could be interpreted through a more dovish lens. The board voted unanimously - with formerly-hawkish Deputy Governor Heath opting to join the majority in lowering benchmark borrowing costs - suggesting that policymakers are shifting focus toward growth risks, away from inflation and the impact that the peso’s recent depreciation might have on prices.
President Claudia Sheinbaum is due to submit her first budget later today, and peso traders will be watching with interest. Although the new president is expected to deliver sharp reductions in spending - with some observers seeing the deficit halving in 2025 after hitting a four-decade high before her predecessor handed over power this year - a more sedate contraction seems more likely as the country braces for a series of deep economic shocks. The International Monetary Fund said in its October Fiscal Monitor that it expected Mexico to record a fiscal deficit of 3.5 percent next year - slightly less than the 3.7-percent emerging market average, and well below the levels likely in many advanced economies - but ratings agencies are growing nervous. Moody’s Ratings lowered the government’s credit outlook from stable to negative this morning, saying that a weakening political and institutional framework will make it difficult to absorb rising debt costs and adjust public spending - but then again, the same could be said of most developed economies.
Economic Calendar