ECB decision coming up, but is it a lose-lose for the euro?
Dollar chops around after US inflation, awaits retail sales
Gold extends losing streak despite falling bond yields
Will the ECB sink the euro?
The highlight today will be the European Central Bank decision, where markets are pricing in a 65% probability of a rate increase. Even though a range of leading indicators suggest the Eurozone is teetering on the verge of recession, the persistence of underlying inflation dynamics coupled with rising energy prices has tilted the scales in favor of a final rate increase.
Some reports that the ECB would raise its 2024 inflation forecasts also fueled speculation that a rate increase is the most likely outcome today. This was seen as an intentional ‘leak’ from the ECB to steer market expectations ahead of the meeting.
For the euro, this meeting seems like a lose-lose situation. Raising rates further when the growth profile is already so dark seems like a policy error, as it would add even further pressure on an economy that’s already on its knees.
Therefore, even if the euro spikes higher on a rate increase, any upside might be short-lived as markets begin to speculate whether higher rates today will further dampen growth and translate into sharper rate cuts next year. And if the ECB doesn’t raise rates, that would come as a surprise for investors given market pricing, pushing the euro lower immediately.
All told, there isn’t much to like about the euro at this stage. Economic growth is rolling over and rising energy prices will put further strain on both economic activity and the bloc’s terms of trade, not to mention the significant exposure to a spluttering Chinese economy. In contrast, the US dollar enjoys solid fundamentals, so the outlook for euro/dollar seems increasingly negative regardless of what happens today.
Dollar undecided after US inflation report
In the broader market, the US CPI report for August was a touch hotter than expected, but that did not unnerve investors. The upside surprises were so minor that traders did not see them as changing the Fed equation.
The dollar and US yields popped higher on the CPI release, before retracing lower once the dust settled. It seemed like a technical rejection in the bond market as the 10-year yield fell sharply after encountering resistance at its cycle highs near 4.35%, without any other fundamental catalyst.
Stock markets capitalized on the pullback in yields and pushed higher in the aftermath, with rate-sensitive sectors such as tech and growth outperforming. That said, the outlook for equities isn’t very attractive. Stagnant earnings growth coupled with stretched valuations in an environment where central banks are draining liquidity and real bond yields are trading near their highest levels in a decade seems like a toxic recipe.
Gold drifts lower, US retail sales coming up
Gold continued its grind lower on Wednesday, despite the retreat in Treasury yields. It seems that the advance in the US dollar overpowered the pullback in yields, pushing bullion lower towards the $1,905 region.
Looking ahead, the near term risks for gold remain tilted to the downside as the dollar rally probably has more miles left in the tank, and the charts reinforce this view as the series of lower lows and lower highs remains intact. For gold to shine again and power towards new record highs, it would likely require recession fears to resurface, which would fuel speculation for Fed rate cuts and knock yields down.
But judging by the resilience of US indicators, this shift does not seem imminent. Investors will get an update on the health of the US economy today in the form of retail sales and producer prices for August.