Financial markets are in retreat after Brazil’s devastating defeat in the World Cup semi-finals, with Asian and European bourses selling off overnight while Wall Street appears positioned for a move down on the opening bell. Investors are downgrading global growth expectations after a series of lacklustre industrial production reports earlier in the week, and are taking defensive positions against what is expected to be a volatile US earnings season.
The greenback is stable against the majors, flat against the euro while remaining depressed against the yen. Canadian dollar traders are overwhelmingly on the sidelines, cautiously awaiting Friday’s job report and gradually edging out of bullish positions as the crude oil price continues its decline. Commodity-linked currencies remain broadly well-supported however, with China’s stimulus programme continuing to support global demand for raw materials – the Aussie, kiwi and loonie are all sitting at elevated levels.
Monetary policy developments are also in focus, with the Federal Reserve due to release minutes from its June meeting this afternoon, and European Central Bank President Mario Draghi scheduled to speak in London later in the session.
In both cases, there are no foregone conclusions for the markets.
Janet Yellen sounded an extremely cautious tone at the last press conference, characterizing recent data releases as “noisy” and suggesting that the central bank would look for a more robust long term trend before accelerating its tapering plans. Judging by the pattern seen for much of the year, the meeting minutes may tell a different story. If optimistic policymakers were already in the ascendant prior to the blockbuster June employment report, investors could begin to position ahead of a monetary pivot, pushing up the short end of the yield curve and kicking the dollar out of its recent range against the yen and euro. If not, bond markets could continue the trend seen over the last few weeks – gradually flattening out as participants temper long-term growth forecasts.
When Mr. Draghi stepped up to the podium in London two years ago, he almost single-handedly reversed the collapse of the euro, saying that he would do “whatever it takes” to defend the common currency.
His encore is unlikely to be quite so impressive.
In fact, he may well consider his earlier efforts too successful – the currency’s stability has had a perverse effect on the euro area, pushing inflation perilously close to zero while damaging external competitiveness. The ECB has come under increasing pressure to dilute the money supply, and a number of policymakers have acknowledged frustrations with the exchange rate in recent statements. Mario is likely to acknowledge these concerns and may attempt to talk the currency down.
We don’t expect the impact to last long, however – the ECB simply doesn’t have the latitude that other major central banks possess. Due to the fragmented nature of the European financial system, it cannot engage in a quantitative easing program remotely comparable to those unleashed by the Bank of Japan and the Federal Reserve over the last decade.
As such, while euro buyers may see some respite in the aftermath of his speech, it would be wise to protect against a reversal. This is a textbook case for the use of trailing stops.
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