Market Brief: Markets Wait to Exhale

Global risk appetite is improving, but trading liquidity remains thin ahead of this morning’s speech from Federal Reserve chair Jerome Powell at the Jackson Hole economic symposium. The dollar is retreating, the pound and euro are inching higher, Treasury yields are flat, and equity futures are pointing to gains at the North American open.

Odds on a half-point rate cut at the central bank’s September meeting have fallen sharply from the early-August peak, but markets nonetheless expect Powell to deliver a distinctly dovish outlook, setting the stage for at least one outsized move in the autumn months by emphasising downside risks in labour markets. We’re not so sure - his counterparts on the rate-setting committee have been far more circumspect in recent appearances, downplaying some of the negative signals embedded in incoming data, and outlining a more gradual easing trajectory ahead. In an interview with the Wall Street Journal’s Nick Timiraos last week, the (admittedly hawkish) Minneapolis Fed President Neel Kashkari said “Unless we start seeing some faster deterioration in the labour market, I’ll probably be in the camp of, ‘Let’s take a more measured approach because we don’t know where our destination is going to be’”.

Extreme moves around Powell’s comments are, of course, possible. But as veterans of previous Jackson Hole hype cycles can attest, the event could also be a complete snoozer: the chair might tell markets what they already know - that risks have come into better balance, giving the Fed room to begin easing policy at a gradual pace - or focus his comments on the still-theoretical factors that are impacting monetary transmission to the real economy.

Data landing in the first two weeks of September should prove far more important in guiding market expectations. The August non-farm payrolls report, Institute for Supply Management update, and August consumer price index print are all due to land before the Fed meets, and could help remove some of the noise present in the summer’s numbers. We expect volatility to resume over the same time period.

The yen is modestly stronger after Bank of Japan Governor Ueda made hawkish noises during a special parliamentary session called to examine the turmoil that hit markets after the central bank’s July rate decision. Ueda told lawmakers that the early-August surge in volatility was primarily triggered by a slowdown in the US economy, but warned “markets at home and abroad remain unstable, so we will monitor market developments with a very high sense of urgency”. “Japan’s short-term rates are still very low. If the economy is in healthy condition, they will move up to levels we consider neutral,” he said. “There is no change to our basic stance of adjusting the level of monetary easing going forward if we can confirm that the outlook for the economy and prices is more likely to realise as we expect”. Data out later in the session showed consumer prices rising 2.8 percent in the year to July - above the Bank’s target - even as the “core-core” ex. fresh food and energy measure slipped below the 2-percent threshold for the first time since September 2022.

Businesses in the United States are struggling to plan ahead, given the extent to which candidates for the country’s highest office seem willing to ignore basic economic fundamentals in generating populist appeal*. But - although it looks as if a possible rail shutdown has been averted - economic policy uncertainty remains far higher in Canada, inhibiting investment plans and lowering overall economic productivity. For decades, the country’s businesses have struggled to understand policy direction from Ottawa, while also dealing with the consequences of over-dependence on a single, politically-turbulent, and increasingly hostile export market.

Risks to the Canadian dollar look tilted to the upside nonetheless. With US economic momentum slowing and the Federal Reserve set to kick off its easing cycle in the coming weeks, the greenback is trading with an increasingly defensive bias, and skewness in options markets is pointing to incremental gains in the loonie ahead. This morning's data should reinforce expectations for three more rate cuts from the Bank of Canada this year, but a late-summer lull in volatility could see the exchange rate add to this week's gains.

*This article in the Wall Street Journal takes a fairly well-balanced view on the dynamics at work. If you’re unable to access it, please email me and I’ll forward a gift link.

Economic Calendar