Marketmind: Turning tides

A look at the day ahead in U.S. and global markets from Mike Dolan.

Turning tides in the year’s twin political and economic shocks dominate the start of the week for world markets.

Ukraine’s dramatic military counteroffensive against Russian troops at the weekend challenged many assumptions of a frozen conflict there for years to come – with potentially profound market implications in energy prices, inflation outlooks and geopolitical risk premia.

Although there was inevitable trepidation about Russian retaliation as Moscow grappled with a collapse of its occupation force in northeastern Ukraine, Ukrainian forces swept further across recaptured territories on Monday.

To the extent the U.S. dollar’s outsize appreciation this year owes something to the heightened geopolitical risks, then its sharp reversal late last week is notable and that continued apace on Monday. The dollar’s DXY index recoiled further to its lowest in more than two weeks and is down 2.7% from 20-year peaks hit only last Wednesday.

The euro – one of the major currencies most affected by the implications of the Ukraine invasion this year – jumped to its highest in almost a month, egged on by a newly hawkish European Central Bank and shifting market forecasts for both its interest rate tightening and balance sheet reduction.

Stocks markets were higher across the world on Monday, with Japanese and European benchmarks up more than 1% and U.S. equity futures up more than half a percent before the open.

But the other turning tide to watch this week is the extent to which U.S. inflation is indeed on the wane.

Critical to the outlook for the U.S. Federal Reserve’s rate hike campaign, August U.S. consumer price data is released on Tuesday and headline annual inflation is forecast to fall back to 8.1% from 8.5% in July – a full percentage point below June’s peak but with “core” rates excluding energy and food prices expected to pick up to 6.1% from 5.9%.

Two-year U.S. Treasury yields nudged higher to a 15-year high of 3.58% in advance, as markets have fully priced another 75 basis point Fed hike later this month. And futures markets see the Fed’s so-called “terminal rate” at about 4% in March.

Brent crude oil prices – which have dropped about 25% since midyear – were not playing ball on Monday, creeping back above $93 per barrel despite global demand worries around COVID-19 restrictions in China and steep interest rate hikes in the United States and Europe.

U.S. Treasury Secretary Janet Yellen on Sunday said Americans could experience a spike in gas prices in the winter when the European Union significantly cuts back on buying Russian oil, but added a proposed Western price cap on Russia’s oil exports is designed to keep prices in check.

While the euro got a lift, Japan’s yen fell back on Monday. Sources familiar with Bank of Japan thinking reckon the central bank is nowhere close to changing its overall monetary policy to support the currency.

Sterling was also higher against the ebbing dollar even though data showed Britain’s economy grew by just 0.2% in July, half of what was expected as a fall in power production reflected sharp rises in energy tariffs.

Key developments that should provide more direction to U.S. markets later on Monday:

* US Treasury auctions 3 and 10 year notes

* Corporate earnings: Oracle

* US-Mexico High-Level Economic Dialogue. US Secretary of State Antony Blinken visits Mexico

(By Mike Dolan; Editing by Edmund Klamann; mike.dolan@thomsonreuters.com. Twitter: @reutersMikeD)