The appetite for risk is fading at the beginning of the week. The dollar and especially the franc and yen are appreciating, as these currencies feel at home in an environment of heightened risk aversion.
The EUR/USD pair has already erased half of its recent rally to 1.18. The EUR/CHF is falling rapidly towards 1.07 after a sharp turnaround. The USD/JPY is trying to find a local low near 109.00.
The latest set of data from the world's two largest economies, the US and China, is fuelling concerns about the sustainability of the recovery. Worrying signs about the Middle Kingdom's economic situation are nothing new, but July's retail sales and industrial production results have inflamed uncertainty and resonate with geopolitical tensions over the Taliban takeover of Afghanistan.
Looking back to China: the weakening consumption can be linked to other factors than increased Covid-19 infections and tighter restrictions. Government efforts to reduce emissions and floods are also co-guilty of weak readings. There are many indications (an epidemic situation, government policies, natural disasters, disrupted global logistics chains) to suggest that activity will remain weak this quarter: 5% growth is probably all that can be hoped for. With the Chinese economy growing at a disappointing pace, it is difficult for the belief in a rapidly improving global economy to become a universal theme for markets again. After all, this is the environment that has been most conducive for representatives of the emerging markets basket in recent months.
Retail sales as the next big test
Contesting for the title of leading investment theme for the world of currencies and bonds (the equity market continues its bull market, the S&P500 has doubled its value against the pandemic low) are therefore the normalisation of policy by the Federal Reserve and the fear of a return of pandemics and tightening. These have very different implications, but both could benefit the dollar, either as one of the defensive currencies or beneficiary of monetary policy. Possibly, as both risk catalogues appear to be firmly covered in its valuation and the current environment. Therefore, we do not expect the US currency to rise further.
Both are unfavourable for emerging market currencies. From the perspective of this basket, the former trend should be preferable, as the market has already become accustomed to it. We definitely do not place an equals sign between a quick (and already practically a foregone conclusion) announcement of the end of quantitative easing and imminent interest rate increases. The US economic picture is not without any flaws either: household sentiment has taken a surprising and sharp downturn. Today's retail sales data, published at 2:30 p.m. (CET), will be another important piece of the puzzle. Another disappointment will probably deepen the correction of the dollar's strength, which has pushed the EUR/USD near 1.18. The market is also waiting for Jerome Powell's speech and tomorrow's publication of the minutes of the Fed's July meeting.