Today's focal point lies in the European Central Bank's decision, with markets assigning a 65% probability to a rate hike. Despite leading indicators hinting at the Eurozone flirting with recession, factors like persistent inflation dynamics and surging energy prices have tilted the balance in favor of a final rate increase. Reports suggesting that the ECB may elevate its 2024 inflation forecasts have only fueled speculations of an impending rate hike. Such news appears to have been strategically released by the ECB to shape market expectations ahead of the meeting.
For the euro, this situation feels like a lose-lose proposition. Raising rates amidst an already dim economic outlook could be seen as a policy misstep, adding more strain to an economy already struggling. Even if the euro initially surges on a rate hike, any gains may prove short-lived as markets question whether the higher rates will further hamper growth, potentially leading to more pronounced rate cuts in the coming year. Conversely, if the ECB opts not to raise rates, it would catch investors by surprise given the market pricing, causing an immediate dip in the euro's value.
In summary, the outlook for the euro appears bleak. Economic growth is declining, and rising energy costs will exacerbate economic challenges, in addition to significant exposure to a slowing Chinese economy. In contrast, the US dollar enjoys robust fundamentals, making the euro/dollar outlook increasingly pessimistic, regardless of today's ECB decision.
US Dollar's Mixed Response to Inflation Data
In the broader market, the US Consumer Price Index (CPI) report for August showed a slight upside surprise, although it did not significantly rattle investors. The minor surprises were insufficient to alter the Fed's trajectory, resulting in a relatively muted response from traders. The US dollar and US yields briefly rose upon the CPI release, only to retrace lower later.
This shift appeared to be driven by technical factors in the bond market, as the 10-year yield encountered resistance at cycle highs near 4.35%, without any major fundamental catalyst.
Stock markets took advantage of the yield pullback, registering gains, with rate-sensitive sectors such as technology and growth leading the charge. However, the outlook for equities remains unattractive, given stagnant earnings growth, elevated valuations, and the backdrop of central banks withdrawing liquidity while real bond yields remain close to a decade high.
Gold's Decline Persists Despite Yield Retreat
Despite the retreat in Treasury yields, gold continued its descent on Wednesday, slipping towards the $1,905 region. The US dollar's resurgence outweighed the yield pullback, pressuring gold lower. Looking ahead, short-term risks for gold are skewed to the downside. The dollar rally seems to have further potential, supported by technical indications such as a pattern of lower lows and lower highs in the gold charts. For gold to regain its luster and make strides towards new record highs, it would likely necessitate a resurgence of recession concerns, sparking speculation of Fed rate cuts and driving yields lower.
However, considering the resilience of US economic indicators, such a shift does not appear imminent. Investors will receive updates on the US economy today, with the release of retail sales and producer prices for August.
