- Dollar falls, risk-sensitive currencies recover as sentiment brightens
- Stock markets are making a massive comeback and continue to rise
- Quiet session today with US on vacation but busy week ahead
Dollar cools
The conversation in the financial markets has changed dramatically in recent weeks. Recession whispers have replaced inflation as public enemy number one, thanks to a growing body of evidence that economic growth is slowing.
Cracks are beginning to appear in the US housing market as rising mortgage rates dampen demand, while big companies like Amazon (NASDAQ:) have announced plans to slow or freeze hiring rates to lower costs. It’s not just an American story either. China may already be in recession, the UK economy is grappling with a sharp slowdown and the eurozone is unlikely to hold out for long.
Bond markets have started to reflect these risks. Government bond yields tumbled for most of the month as slower economic growth was burned into the cake and inflation concerns eased. The Fed could even hit the “pause” button by September if the economy underperforms, according to Bostic.
All of this has taken the shine off the US dollar and the question is are we in the early stages of a trend reversal. Of course, not much has changed in the basic picture. Most economies are in worse shape than America, and a global recession would likely drive safe-haven inflows into the reserve currency, so this still looks like a correction to the broader uptrend.
There are three basic catalysts that could trigger a reversal in the dollar – the Fed halting its tightening cycle, the war in Ukraine ending, or China abandoning its zero-Covid policy. Until then, calls for a dollar demise are premature.
Riskier currencies bounce with stocks
As always, a falling US dollar lifted all other boats in the forex market. Dollar/yen reflected the slow downtrend in Treasury yields and amid speculation that the Bank of Japan may adjust its yield curve management strategy after inflation has started to shoot up, further relief may be on the horizon.
Similarly, the British pound and other risk-sensitive currencies have rallied nicely. It could be argued that the fundamental outlook for sterling has deteriorated as recent UK business surveys herald a sharp slowdown in economic activity, so this recent rebound appears to be linked to improved sentiment in equities.
Stock markets have traded like a pinball, with the S&P 500 up nearly 10% in just over a week after the index plunged into bear market. Many are attributing this stunning recovery to Fed bets, which have been scaled back on signs that inflation has peaked.
However, that’s not very convincing. If the Fed’s course is truly recalibrated on worries of an economic slowdown, stocks should feel the pain too as earnings estimates are revised down. Instead, this appears to be mostly a bounce in recovery driven by oversold conditions and short covering.
Oil prices and upcoming events
In the energy space, oil prices continue to rise as demand shows no sign of slowing down and supply remains constrained. Windfall taxes on energy company profits, such as those introduced by the UK, could actually make matters worse by discouraging new drilling and investment in the industry.
On the bright side, the Biden administration hit the panic button ahead of the US midterm elections, sending diplomats to Saudi Arabia for “secret talks” to boost production.
Not much on today’s agenda as only German inflation data is available. US markets will remain closed during the Memorial Day holiday, so liquidity will be lower than usual. The remainder of the week includes a Bank of Canada meeting and the latest US jobs report. 
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