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Market Wire
Currency Markets Stabilize Into Quarter-End

Karl Schamotta September 28, 2018

After a five-month winning streak, American consumer spending cooled slightly in August, but continued to rise – and a measure of underlying inflation hit the Federal Reserve’s target for a fourth time this year. Consumer spending, which accounts for roughly two-thirds of economic activity, rose a seasonally-adjusted 0.3 percent in August, according to numbers released by the Bureau of Economic Analysis this morning. This represents the slowest growth recorded since February, but remains relatively strong, with strong household balance sheets and high sentiment levels helping to motivate consumer outlays.

Inflation as measured by the personal consumption expenditure price index rose 0.1 percent in August, weakening slightly to 2.2 percent on an annualized basis – down from 2.3 percent in July. The Federal Reserve’s preferred measure – the ‘core’ index which excludes food and energy prices – remained flat in August, up 2 percent on a year-over-year basis.

North of the 49th, the Canadian dollar is up modestly after data was released showing that the economy expanded 0.2 percent in July – slightly above market expectations after a flat number in June. Performance was mixed across sectors, with domestically-focused segments like retail, finance and construction suffering modest losses, while the manufacturing, wholesale trade and transportation groupings experienced growth – validating our belief that the Canadian economy is slowly rebalancing toward external demand. Somewhat-surprisingly, real estate activities grew 0.3 percent in the month, reinforcing a sharp rebound after a 13.5 percent decline in the first quarter.

Over the weekend, the White House will submit the text of its trade agreement with Mexico to Congress, leaving negotiations with Canada to continue into October. Contrary to some alarmist headlines, this doesn’t represent the collapse of the North American Free Trade Agreement itself – Canadian dollar traders have largely resigned themselves to a ‘muddle-through’ scenario in which the Bank of Canada hikes interest rates in October, even as the Trump Twitter feed raises the background threat level.

In the wider currency markets, the euro has come under sustained selling pressure, with fiscal and inflation concerns taking a toll on monetary tightening expectations.

Italy’s government triggered a sharp rise in local yields yesterday, agreeing a budget that will incur an annual deficit of 2.4 percent of gross domestic product over the next three years, and put the country into conflict with European Union mandarins. Investors are increasingly concerned about Italy’s fiscal outlook – it is currently carrying the second-highest debt burden in the euro area – but with small immediate refunding needs and much of the outstanding issuance held by domestic bondholders, prospects for contagion look relatively limited.

Instead, softer-than-forecast September inflation data released by Eurostat this morning could have a longer-term impact. Headline eurozone prices increased to 2.1 percent on a year-over-year basis from 2.0 percent a month ago – but the less-noisy core inflation rate fell to 1.1 percent from 1.2 percent, suggesting that the European Central Bank’s fourth-quarter projections could miss the mark. The central bank is due to wind its asset purchases down at the end of December, but renewed price weakness could push the date of its first interest rate increase well into late 2019.

Bottom Line: The US dollar remains a metaphorical rock in a sea of troubles (albeit one with a number of extremely obnoxious seagulls sitting atop it). The growth outlook for other Group of Ten countries and the emerging markets remains uncertain, and increased confidence in the forces compelling the Federal Reserve to hike rates next year is helping to lift the greenback against its counterparts – but a narrowing in growth differentials could yet trigger a rush out of an overcrowded elevator during the fourth quarter.

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