Market Volatility and Rate Cut Expectations Drive Dollar Lower as Yields Rise
Last week saw a whirlwind of unexpected developments in the financial markets that left many investors reeling. The shift towards a risk-on approach caught many by surprise as major indices like the DOW and DAX soared to new record highs. This optimism was largely fueled by expectations of forthcoming monetary easing from key central banks, including the Federal Reserve (Fed) and the European Central Bank (ECB). Despite growing concerns of a recession in the US and Germany, the focus remained squarely on potential rate cuts, leading to a significant outflow from treasuries, particularly at the longer end, which subsequently pushed yields higher.
The Euro ended the week as the weakest performer, weighed down by growing speculation that the ECB might implement more aggressive rate cuts. The Japanese Yen also struggled under the pressure of rising US benchmark yields, while the British Pound rounded out the bottom three currencies.
Conversely, the New Zealand Dollar emerged as the standout performer, defying expectations and unexpectedly claiming the title of the strongest currency of the week. The Kiwi’s resilience, even in the face of the RBNZ’s surprise rate cut earlier in the month, reflected a significant shift in market sentiment. The Canadian Dollar also posted strong gains, finishing as the second-best performer, while the US Dollar took third place, buoyed by its sensitivity to rising yields rather than the prevailing risk-on sentiment. Meanwhile, the Swiss Franc and Australian Dollar found themselves in the middle of the pack.
Market Euphoria Meets Recession Warnings as Fed Easing Looms
The financial markets experienced a mix of euphoria and caution as investor sentiment soared with the DOW reaching new record highs and the S&P 500 notching its fourth consecutive winning month. This optimism was largely driven by expectations of the Fed initiating a policy easing cycle in September. However, while the market embraced a more accommodative Fed, expectations for a bold 50 basis points rate cut have slightly tempered.
This shift in sentiment comes as key recessionary signals, such as the normalization of the US yield curve, are being largely overlooked. The late rebound in the 10-year yield hints at potential further upside, raising concerns of a widening yield spread. Historically, this has often been a precursor to a looming US recession, indicating that the economy may be edging closer to a downturn.
The Sahm Rule, which links rising unemployment to recessions, could quickly re-enter the narrative with one weak jobs report in the coming Friday. Should such a scenario unfold, it might boost the odds of a more aggressive rate cut, though the market’s reaction to such a development remains highly uncertain.
Technically, the DOW’s firm break of resistance confirms the resumption of the rise from the low in 2022. In the near term, the outlook will remain bullish as long as support holds. The next target is a projection from the low to the high at 61.8%.
In the bigger picture, the rise from the low in 2022 is still in a healthy state, staying well above the rising 55-week EMA. The MACD’s cross above the signal line suggests there could be medium-term acceleration ahead. The next target is tentatively a projection from the low to the high at 100%.
Subheadings:
### DAX Surges to Record Highs Despite Growing Recession Risks
In Europe, expectations for another ECB rate cut in September are solidifying with recent data showing a decline in wage pressures and a notable drop in headline inflation. Even core inflation, although decreasing at a slower pace, is trending downwards. However, these positive signs are overshadowed by growing concerns of a recession in Germany, highlighted by disappointing PMI readings, declining Ifo business confidence, and weak Gfk consumer sentiment. Despite these economic warning signs, DAX surged to a new record high, reflecting investor optimism that ECB easing might bolster the economy, even if the pace of rate cuts accelerates due to worsening conditions.
DAX’s powerful rally from continued last week with a break of resistance. The outlook will now stay bullish as long as the holds. The next target is a projection from the low to the high at 61.8%.
In the bigger picture, the rise from the low is also healthy, with strong support seen from the rising 55-week EMA. The next target is a projection from the low to the high at 100%.
### Kiwi Tops August Performance, Defies Impact of RBNZ’s Surprise Rate Cut
The New Zealand Dollar ended the week as the strongest currency, surprising many as it also claimed the title of the best performer in August despite the RBNZ’s unexpected rate cut earlier in the month and subsequent volatility. This rate cut, marking the beginning of a monetary easing cycle, is now viewed as a well-timed strategic move that came just as market sentiment was shifting. This preemptive action by the RBNZ is expected to provide the economy with a significant boost, reducing the need for prolonged or more aggressive policy easing in the future.
Kiwi’s strength was bolstered by the latest ANZ Business Outlook survey, which revealed a sharp rise in business confidence. Although firms remain cautious about current activity levels, the survey showed that headline confidence surged to a decade-high. Additionally, firms’ expectations for their future activity reached their most optimistic level since 2017. This surge in optimism was already evident before the RBNZ’s rate cut, suggesting that confidence may continue to build as the effects of the rate cut take hold.
NZD/USD was the top mover of the month, gaining 5.01%. The break of the medium-term falling trend line resistance suggests that the corrective pattern has completed. Further rally is now expected in the near term as long as support holds.
Subheadings:
### USD/JPY Weekly Outlook
The USD/JPY edged lower to last week but recovered notably. The initial bias remains neutral this week. On the upside, a break of resistance will argue that the pullback has completed, and the rebound is set to resume. Intraday bias will be back on the upside for first and then a projection from the low to the high at 100%.
In the bigger picture, the fall from the medium-term top is seen as correcting the whole uptrend from the low. Deeper decline could be seen to 38.2% retracement, which is close to support. In any case, the risk will stay on the downside as long as the 55-week EMA holds. Nevertheless, a firm break of the 55-week EMA will suggest that the range for the medium-term corrective pattern is already set.
In the long-term picture, it’s still early to conclude that the uptrend has completed. However, a medium-term corrective phase should have commenced, with the risk of a deep correction towards the 55-month EMA.
Overall, the financial markets are experiencing heightened volatility and uncertainty as rate cut expectations drive the Dollar lower while yields rise. Investors are navigating a delicate balance between market exuberance and looming recession risks, as central banks prepare to take action to shore up their economies. The coming weeks will be crucial in determining the trajectory of global markets and the impact of monetary policy decisions on currencies and yields.
