What Happened

• USD managed to escape July with a 0.2% uptick per the Bloomberg Dollar Spot Index.
• Commodity-based and Emerging-Market currencies recovered with heightened volatility.
• Norwegian Krone (NOK) and Chilean Peso (CLP) were the best performers for representing major suppliers of natural gas.
• Euro dropped below parity momentarily while dealing with a crippling energy crisis.
• Central banks continued tightening, but the Bank of Canada surprised all with a full 1.0% increment.

GreenShootsFX’s View

• The debate over how deep of a recession we will experience will keep FX flows wild.
• August will test Europe’s economic stability as people go on holiday, use gasoline, travel.
• China’s ongoing problems make for a tough overall recovery while diplomatically engaging with the U.S. over trade and Taiwan relations.
• Equities will try sustaining momentum as Wall Street embraces the idea of a short downturn.
• Greenback may have room to lose following a less hawkish Fed in its latest hike decision.

In Focus

• Fed officials reached a consensus on its fight against inflation.
• The Federal Reserve remains committed to fighting inflation and vowed to continue its planned hike path.
• Nevertheless, Fed Chairman Jerome Powell warned that there might come a time to slow down tightening and leave rates unchanged.
• Powell also suggested that the next interest rate increases may not be as clearly defined and predictable as the first half of the year.
• Fed admitted to erroneously believing originally that inflation was transitory and not reacting.

In Depth

Recessionary pressures are here to test the dollar’s buoyancy and the rest of the year will be defined by how deep the struggle gets.

Moody’s Chief Economist Mark Zandi, frequently one of America’s most reliable sources for questions over economic forecasting, recently said to the press: “we are talking ourselves into a recession.” Following the Gross Domestic Product release on July 28th, it looks like we most certainly convinced ourselves that the economy should not be expanding.

An unexpected contraction of (-0.9%) to GDP revealed that Q2 absolutely came with bumps and bruises. Much like Zandi, U.S. economists did not foresee it and thought the situation should not amount to a gloom and doom scenario.

However, it looks inescapable that the first half of the year has brought on difficulties for both suppliers and consumers that have not completely overcome the insecurities emanating from the pandemic and war.

When it comes down to it, the U.S. is in an enviable position compared to the rest of the globe, which has been experienced through record rallies in the dollar’s value. Moreover, the U.S. is not bordering any enemies actively engaged in heated conflict; it can produce food on its own and it can count on various energy sources.

While things may not all be coordinated ideally, the U.S. economy continues to have a tight labor market, and the government has stepped up to try to alleviate the financial pain on the most vulnerable households. So naturally, the Fed has acted according to its planned path of tightening and hiking interest rates.

Throughout various times being asked about what effects the Fed expects their measures to have on the economy, Powell has explained that monetary policy action can trigger a recessionary period.

To help bring prices down, the economy must be cooled off; this is the logic. We are now seeing the effects across purchases of everything, with Housing and vehicles taking a noticeable decline. Powell also warned in his press conference post-hike that future moves will be more data dependent.

July Purchasing Managers Index figures showed a contraction as suppliers dealt with supply-chain woes and increased costs all around, making it difficult to invest in production. Industries are not thriving, and the American consumer keeps tightening their spending as elevated prices for basic items and gas continue to make life difficult.

Whether the National Bureau of Economic Research (NBER) wants to call it yet to not, it feels to us all that we are going through a recession, but the question now is what can be done to turn things around quickly.

As criticism mounts on the White House to do more for the economy, we believe there will be more progress in coordinating with Congress to pass legislation such as the latest climate and semi-conductor bills. In addition, the administration did good in using its Strategic Petroleum Reserves, guaranteeing supplies at lower prices, and working already on contracts to replenish them.

On the other side of the Atlantic, fossil fuels are far scarcer. Much of what caused the Euro to plummet as it did for the month came from speculation and worry over Russia’s willingness to completely shut off its neighboring European countries from natural gas and other energy exports.

The key Nord Stream pipeline that feeds mainland Europe was shut down temporarily for maintenance, but the havoc arrived once Gazprom announced that it would be cutting supplies by an additional 20.0% going forward.

Russia and Ukraine continue to fight intensely, and European leadership has vowed to remain on the side of the invaded. Nevertheless, it is getting scary to think this is a conflict without an end in sight anytime this year or next. Even countries such as Spain are rebuilding their military, adding €10.0BN to defense spending, displaying long-term commitment to protecting Europe in their budget.

We shall see if the Euro counters its trend to fade in August. Out of the past 15 years, there have been ten instances of retreat against the greenback.

Meanwhile, U.S. and its allies are trying to work on deflating the price of oil barrels to truly inflict damage to the finances of the Kremlin. Whatever globalized world we knew before this year has been forever changed: Russia is selling products to whoever has Rubles to pay them, the European Union is legally battling trading protocols with the U.K, Africa is looking for grain suppliers, and strict safety measures plague China’s economy. The world’s second-largest economy only grew by 0.4% in Q2, the weakest pace of growth since COVID arrived in 2020.

The world is hurting from a very strong dollar, as experts point out the “Dollar Doom Loop” taking place: as the buck strengthens, it drags down economic activity, which then triggers a flight towards the safety of the dollar that only reinforces its value further and so on. The financial system was rebuilt with the U.S. Dollar as its primary catalyst after World War II, but the inter-dependent globalized system that it thrives on is facing what could be lethal challenges to the arrangement.