AI stock selloff raises concerns of potential economic slowdown + More

Analysts caution against overreliance on US consumer confidence report

by Faruk Imamovic
AI stock selloff raises concerns of potential economic slowdown + More
© Getty Images/Michael M. Santiago

Economic analysts await with great interest the latest data on inflation in Canada, which could significantly influence the monetary policy of the Central Bank of Canada (BoC) in the coming period. A low inflation rate could increase the likelihood of interest rate cuts as early as July, which would have far-reaching consequences for the Canadian economy and the currency market.

Key economic indicators under scrutiny

As attention turns to Canadian inflation, experts caution against taking too much credit for today's Consumer Confidence report from the Conference Board. This measure of US consumer confidence became politicized after 2000, with marked differences between Democrats and Republicans. Instead, analysts recommend tracking actual spending trends and measures of household liquidity to more accurately gauge the outlook for U.S. spending.

It is expected that another low inflation data in Canada could increase the likelihood of a BoC interest rate cut in July from the current 55% to as high as 70%. Such developments could widen the spread between US and Canadian two-year yields in favor of the US, which could lead to a strengthening of the US dollar against the Canadian dollar, potentially pushing the exchange rate above 1.37.

In European markets, there is a noticeable decline in enthusiasm, where concerns about corporate earnings of companies such as Airbus negatively affect the main stock indices. However, in the US, Nasdaq 100 index futures are showing signs of stabilizing after yesterday's significant drop caused by a sell-off in AI-related stocks.

Markets under pressure

Some analysts suggest that yesterday's fall in artificial intelligence (AI)-related stock prices is not a macroeconomic story, but rather a correction of overvaluations. However, there are concerns that the AI ​​stock sell-off could turn into a macroeconomic problem if there is significant "wealth" destruction due to overly optimistic profit projections, overvaluation, or exaggerated promises of increased productivity through AI. This situation is reminiscent of the dot-com crash of 2000, which led to a slowdown in the economy and a recession in early 2001.

Currency markets are currently showing relative stability, partly due to the lack of fresh data in Europe. However, there are growing concerns about the possible collapse of the ruling coalition in Germany (SPD, Greens, FDP) if no agreement on the 2025 budget is reached by July 3. This uncertainty, together with the upcoming elections for the National Assembly in France on June 30 and July 7, further weighs on the euro ahead of the end of the month.

Markets under pressure
Markets under pressure© Getty Images/Michael M. Santiago

The American Economy

The publication of the Conference Board consumer confidence index in the US is expected today. If the headline index falls below 100, it could cause bond yields to fall or the dollar to weaken. In general, measures of consumer confidence in the US remain significantly lower than before the pandemic, which presents a puzzle given otherwise strong labor market conditions and high stock prices.

Many analysts link this decline to political conditions and polarization. In a University of Michigan poll, Democratic sentiment is near or above pre-pandemic levels and has remained fairly high over the past four years. However, Republican sentiment is extremely low and began to plummet with the onset of the 2020 pandemic. Consumer confidence today seems to depend more on who is in power in Washington than on actual economic conditions.

Focus on Federal Reserve speeches and the labor market

In speeches by members of the Federal Reserve (Fed) this week, it is important to pay attention to possible changes in tone that could indicate a more dovish stance by key members of the FOMC in light of recent signs of a slowdown in the US economy. The fact that initial claims for unemployment insurance in the US have broken their stable low level cannot be ignored. Although the change in labor market indicators seems tentative, initial claims are at levels around 18% above cyclical lows, while continuous claims are more than 30% above cyclical lows.

How Fed speakers acknowledge or don't acknowledge this shift could be a key driver of the dollar this week. Of course, this must be seen in the context of the speeches of other central banks. For example, the European Central Bank's Philip Lane will speak at a monetary policy conference on Wednesday. Meanwhile, the US Treasury will auction two-year and five-year bonds today and tomorrow, which could set the pace for medium-term dollar yields.

Outlook for the Canadian dollar

Analysts' view on the USD/CAD exchange rate remains largely unchanged; they predict a slow move towards 1.40 by the end of the year. This is a result of expectations that traders will begin to consider the relative slowdown that will occur in Canada in 2025, when the effect of mortgage adjustment (after a large increase in five-year yields after 2000) will adversely affect household cash flows and consumers will find under pressure.

The spread between US and Canadian two-year government yields widened in June, and analysts expect USD/CAD to follow that trend. They also note that there has recently been an increase in speculative long USD/CAD positions via futures and options (as reported by the CFTC).