In the perverse FX world, the euro is likely to drop even if the ECB does do the 75 bp

Outlook: The upcoming data features the new and improved ADP private sector payrolls estimate, thought to be about 280,000-300,000. The stage having been set by JOLTS, it would take a big discrepancy from the expected to have much of any effect. The new ADP report will contain a ton more data, confusing everyone.

For North America, Canada reports June and Q2 GDP and the Mexican central bank will release the quarterly inflation report. Both currencies are more responsive of late to their own fundamentals and both are suddenly falling, a little odd since both central banks have recently been tracking the Fed come hell or high water. Canada is expected to raise rates by 75 bp at the Sept 7 policy meeting. There is chatter about 100 bp but that seems doubtful. 

The market is pricing in that 75 bp rate hike by the ECB next week. We don’t buy it for a minute. The ECB is not known for aggressiveness or giant rate changes. We have had chatter in years gone by of some big change or another and it never comes to pass.

The ECB gave up forward guidance but what we do have is the strong suggestion of 50 bp. It would be rare to do more than the 50 bp signaled and 75 bp would be unprecedented. The implication is clear—all those euro buyers are going to dump their positions as fast as they can. The euro should drop well below 95 and perhaps more. In fact, we expect this action to start as early as today as experience and common sense get a grip. In the perverse FX world, the euro is likely to drop even if the ECB does do the 75 bp—on plain, old-fashioned profit-taking. Then attention can turn to the looming recession. Currencies do not go up in recessions.

Separately but in the same context, Brown Brothers writes “We believe the single currency remains on track to test the September 2002 low near $0.9615.”

The top left front page story in the FT today is about “king dollar,” a repulsive term. “The dollar is on the cusp of its third straight month of gains after reaching a 20-year high against peers, in a stark reflection of diverging outlooks for interest rates and growth in the world’s largest economies.”

The dollar index is up 14% year-to-date on acknowledgment the Fed is not going to chicken out and also on “worries that soaring energy prices in Europe stoked by Russia’s war in Ukraine will drive inflation higher and push economies into recession.” The FT notes the 2-year yield hit its highest level since 2007, at 3.497%, yesterday.

The paper also warns that the higher US yields and stronger dollar are especially hard on emerging markets with debt denominated in dollars. For Europe, the energy crisis is calling for emergency initiatives but as we wrote yesterday, it’s a bit late and a bit short. A Rabobank analyst said [the EU] can’t “really put up a decent fight against king dollar when we’re looking at this really sour backdrop. If you’re going to sell the dollar, what are you going to buy?” Again, as we wrote earlier this week in the context of reserves.

What is most confounding is the fixed income market gyrations. As the FT reports, “German and UK government bonds were on track to close out one of their worst months on record, as investors braced themselves for eurozone inflation data that may influence the path of rate rises.

“The 10-year German Bund yield, seen as a proxy for borrowing costs across the eurozone, has climbed 0.66 percentage points in August to trade at 1.49 per cent — reflecting its biggest monthly surge since 1990. The two-year Bund yield, which tracks interest rate expectations, was on course to post its biggest jump in more than four decades.”

“In the UK, short-dated gilt yields have risen more than 1.2 percentage points in August, their steepest ascent since 1994 — adding 0.06 percentage points on Wednesday to 2.95 per cent.” The FT doesn’t address the rise in Italian yields vs. the Bund, apparently a function of hedge funds betting against the Italian economy and the September election. 

See the chart comparing 2-year yields and the euro/dollar. We still find it astounding that the only source of such a chart that we have been able to find is from Kshitij in India. This chart is constructed upside down, from the American perspective—the Bund minus the US 2-year instead of the other way around. The currency implication is for a corrective bounce in the euro but then resumption of the downmove to a bigger negative differential. 

We need to keep in mind that anti-dollar sentiment remains a strong underlying force and the dollar can fall on the slightest pretext while the euro can remain firm despite data that would fell the dollar or any other currency.

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