Market Sentiment Shifts as Global Risk Aversion Rises; US Dollar Attempts Recovery Amid Nvidia's Continued Decline

Global risk aversion has gripped market sentiment, leading to a recovery attempt by the US dollar while Nvidia extends its two-week decline to 15%. The S&P 500, a key benchmark for US equities, dropped by more than 2% in yesterday’s session, marking its worst performance since the August 5th selloff. Investors have been increasingly reallocating capital to safe havens since early last week, driven by concerns over upcoming US macroeconomic data that could influence the Federal Reserve's future decisions.

The week began on a negative note, with weaker-than-expected Chinese PMI data setting a cautious tone for global markets. The US manufacturing PMI that followed did little to alleviate these concerns, despite an improvement for the first time in five months. The index registered a reading of 47.2, still below the 50-point threshold that separates expansion from contraction. Although the employment sub-index rose from 41.7 to 43.6, it remained in contraction territory for the third consecutive month. A cautious outlook over the next 3-4 months is justified as the key leading indicator—the ratio between new orders and inventories—continued to decline.

On a more positive note, the Economic Optimism Index reached its highest level since April 2023, reflecting an improved personal financial outlook among households. While this data isn't directly market-moving, the ongoing ambiguity in economic indicators is supporting the US dollar. Investors may remain cautious throughout the week as they await the significant US jobs report due on Friday.

The US dollar is likely to stay strong this week, buoyed by expectations of a rebound in job growth. However, market reactions could hinge on the unemployment rate. A slight 10 basis point increase might unsettle markets and increase the likelihood of a 50-basis point rate cut from the Fed in September. In the meantime, markets will look for further direction from the July US job openings data set to be released tomorrow and the ISM services report due on Thursday.

British Pound Trends Lower Amid Volatile Trading, Faces Pressure from Global Sentiment

The British pound continued its downward trend in yesterday’s session but remains within its upper short-term trading range. In August, the realized volatility of GBP/USD surged to 4.7%, as the currency pair fluctuated between $1.2660 and $1.3260 over just 13 trading days. Since peaking last month, the pound has declined by about 1%. Although August is typically the pound's weakest month historically, this seasonal pattern did not emerge this year. However, the weak outlook for equity markets as Q3 ends could put additional pressure on the pound.

With no significant domestic catalysts this week, global sentiment will likely determine the direction of the pound. Fortunately, yesterday’s bond sale by the new Labour government did not unsettle markets. The British government attracted over £110 billion in orders for the bond auction, matching a record set in June for the highest demand relative to the auction size. For the first time in a while, political developments are not seen as a negative factor for the pound.

Euro Struggles Amid Rebounding Dollar and Weak Equity Markets

The euro has been hit hard by the rebounding US dollar and weaker equity markets, after gaining approximately 4.5% since the start of July. The initial rise was largely driven by expectations of Federal Reserve easing and a potential slowdown in the US economy. However, these assumptions have been challenged as the US economy outperformed in the second quarter of 2024.

Across the Atlantic, optimism has waned. German sentiment indicators turned negative in July and August, and inflation in Europe’s largest economy has dropped below the 2% target. This has resolved the debate over whether the European Central Bank will ease policy at its September meeting. Our cautious stance on the euro around the $1.12 level has proven accurate, as key indicators, including the real rate differential, suggest the currency pair will remain near its current rate of $1.1050. This is still above the 2-year average of $1.07 and this year’s mean of $1.08. Currently, EUR/USD is trading in the upper half of its 3-, 6-, and 12-month ranges.

With European macroeconomic news likely to stay in the background, any further increase in the exchange rate would likely depend on rising recession risks in the US, as there is limited room for additional Fed easing in 2024 or early 2025.