Positive Economic Data Fuels Risk Sentiment as Focus Shifts to Fed's Rate-Cutting Prospects
US inflation continues to ease, initial jobless claims were lower than expected, retail sales in July saw their best performance of the year so far, and consumer confidence rose for the first time in five months. These positive developments contributed to upbeat risk sentiment last week. Investors focused on the disinflation narrative and a risk-on rally, leading to a sell-off in the dollar, despite lower recession probabilities that would typically support the Greenback.
This reaction can be understood through the perspective of Fed funds futures. Stronger macroeconomic data have increased the likelihood of a 25 basis point rate cut in September (rather than 50 basis points), with around 175 basis points of cuts priced in over the next 12 months. This significant expectation of easier monetary policy has weighed on the dollar.
Jerome Powell’s upcoming speech at the Jackson Hole Symposium later this week is expected to shed more light on the Federal Reserve’s response to recent economic data. Options markets are currently predicting a swing of over 1% in the US equity benchmark (S&P 500) on Friday, driven by Powell’s address. The focus has shifted from whether the Fed will cut rates in September to the extent of the cuts. For risk assets to continue their upward trend, Powell will need to reinforce this message. Investors are optimistic about imminent rate cuts and are betting on reduced volatility, with the central bank’s data dependency highlighting the importance of upcoming macroeconomic data.
British Pound Recovers as GBP/USD Surges Amid Easing US Inflation and Strong UK Economic Data
GBP recovered its losses from the previous three weeks in just one week, with GBP/USD rising by 1.4%. This was the currency pair's fourth-best performance of the year, driven by easing inflation in the United States and the UK economy surpassing expectations.
US bond yields are falling more swiftly, shifting the rate differential in favour of the pound. For the first time since last September, investors are now receiving a higher yield from British 10-year government bonds compared to US Treasuries. This shift has helped GBP/USD climb back to the high $1.29 level, with $1.30 now clearly in sight.
From a macroeconomic standpoint, August has effectively concluded for the UK, with all pertinent data released last week. Retail sales, GDP, and labour market figures all surpassed expectations, while inflation increased more gradually than anticipated. This news will be welcomed by the Bank of England, which is striving for a smooth economic transition and now faces uncertainty over its next rate decision. The positive developments are likely to bolster the pound for a period, but the direction of the currency pair will ultimately hinge on upcoming US economic data.
Euro Gains from Risk-On Sentiment as Focus Shifts to US Economic Data and Fed Expectations
The euro has recently gained from a renewed risk-on sentiment, despite investors recalibrating their expectations for substantial Federal Reserve easing in 2024. Positive economic data from the US have alleviated fears of a sharp economic downturn. This, combined with the renewed risk-on sentiment and enhanced market stability, has propelled EUR/USD close to its 2024 peaks.
Domestically, growth remains largely supported by the services sector, while manufacturing continues to struggle, with industrial production falling sharply. Recent indicators, such as Germany’s ZEW survey, have worsened, reflecting growing uncertainty and concerns about global events. Despite these challenges, investors are currently more focused on US developments and the Federal Reserve’s outlook.
This week’s negotiated wages data could shift attention back to the European Central Bank (ECB), as this metric is crucial for the Governing Council when considering future rate cuts. Recent data from Italy have shown persistent upward wage pressures, and if this trend is reflected in broader Eurozone figures, it could challenge expectations of an ECB rate cut in September, potentially boosting the euro. Flash August PMIs, due later this week, will also be important for assessing growth momentum. Any further signs of deterioration could diminish some of the euro’s recent gains.
