How to Invest in Chaotic Markets - The Number One Rule: Keep A Cool Head

Commodity prices dropped in July as concerns about the state of China's economy linger. Oil prices declined by 6% last month to 81 USD per barrel, as weak Chinese GDP growth and poor European manufacturing activity outweighed the drop in US inventories. That said, increasing Middle East tensions and a possible tightening of sanctions on Venezuela (in the wake of its contested election) could drive prices back up in August. Gas prices, meanwhile, increased mildly in July, reaching 35 EUR per MWh. But high EU gas storage levels (filled at 85% now), are keeping prices in check. Low Chinese demand is also weighing on metal prices, which declined by 3.4% last month. Food prices, meanwhile, were broadly flat last month as increases in meat, sugar and vegetable oil prices were compensated by a large drop in cereal prices.

In the euro area, inflation rose slightly in July to 2.6%, 0.1 percentage point higher than in June and as high as in May. The increase was driven by energy prices, which were 1.3% higher than a year earlier compared with an increase of only 0.2% in June. Core inflation (inflation excluding energy and food prices) stabilised at 2.9%. The annual rate of increase in non-energy goods rose slightly from 0.7% in June to 0.8% in July, while services inflation slowed from 4.1% to 4.0%. The latter is encouraging, although the still high figure signals that the cooling of services inflation remains slow. We expect it to continue gradually, sustaining the downward trend in headline inflation. However, volatile energy prices will continue to provide a bumpy inflation path, also due to remaining base effects.

US inflation indicators have evolved favourably lately. US inflation surprised to the downside in June, declining from 3.3% to 3.0% year-over-year (-0.1% month-on-month). Within non-core components, energy prices declined by 2% in June, while food prices increased by 0.2%. Core inflation was also soft in June, declining from 3.4% to 3.3%. Goods prices declined marginally thanks to a big drop in vehicle prices. Services were also broadly unchanged (for the second month in a row). This was partially thanks to a big drop in airline fares, though other stickier components were also soft. Especially encouraging was the deceleration in shelter inflation, which only increased by 0.2% last month. Forward-looking indicators have also been evolving favourably for this important category. Wage data have also been encouraging lately. The employment cost index softened from 1.2% to 0.9% last quarter. This favourable wage evolution continued in July as average hourly earnings only increased 0.2%. Furthermore, productivity growth accelerated rapidly last quarter, keeping unit labour costs under control. Inflation expectations have also edged down; according to the University of Michigan Survey, consumers now expect 2.9% inflation in the year ahead (down from 3.3% in May).

The ECB and the Fed kept their respective policy rates unchanged in July. However, given the increased confidence of both central banks that the respective disinflationary paths in the US and the euro area are intact, both suggested that a rate cut in September is on the table. For the Fed, this would be the first in this rate-cutting cycle. Though a September cut was already priced in by markets, the case for a Fed rate cut has further strengthened following weaker-than-expected US net job creation in July. Given the Fed's dual mandate of price stability and maximum sustainable employment, the waning strength of the labour market, supports expectations for an imminent start to the rate cutting cycle

According to Eurostat's preliminary flash estimate, real GDP in the euro area increased by 0.3% quarter-on-quarter in Q2 2024. This is slightly stronger than expected and equal to growth in the first quarter. Both figures confirm that the expected economic recovery in the euro zone is gaining momentum, but not at a strong pace. The persistent malaise in the German economy, which contracted slightly in the second quarter (-0.1% compared to the first quarter), and the as yet absence of convincing signs of broad-based private consumption growth point to persistent growth pains. The relatively strong growth rate in the euro area was mainly due to the Spanish economy continuing to perform strongly (+0.8%), and the high but often very volatile Irish growth rate (+1.2%). We maintain our expectation that the ongoing recovery in purchasing power through real wage catch-up will spur private consumption, supporting a gradual growth recovery. However, recent disappointing indicators on business confidence highlight the downside risks to the growth outlook.

The US economy showed signs of resilience as Q2 GDP figures surprised to the upside. GDP grew by 0.7% last quarter. The most important contributor was private consumption, which contributed 1.57 pp to the annualised rate of 2.8%. Non-residential fixed investment made a solid 0.69 pp contribution, but this figure was embellished by strong airline deliveries, a likely one-off. The biggest upward surprise came from inventories, a highly volatile component, which made an impressive 0.82 pp contribution. Net exports and residential fixed investments made negative contributions. Looking to the coming quarters, GDP growth is likely to slow. Most importantly, the labour market has weakened sharply. The labour market added only 114k jobs last month compared to 179k the month prior. Unemployment also rose from 4.1% to 4.3% in July, while average hours worked ticked down. Aside from the labour market, consumer spending is also likely to weaken as savings rates are very low and consumer confidence is on a declining trend. A soft landing is thus likely to happen in the coming quarters.

The Chinese economy continues to struggle, expanding only 0.7% quarter-on-quarter (or 4.7% year-on-year) in the second quarter—a measurable slowdown compared to the start of the year. A relatively weak contribution from consumption (2.2 pp to the year-on-year figure) highlights how dismal consumer confidence and several structural headwinds are weighing on domestic demand. The government's economic meetings that took place at the end of July reiterated goals of technological upgrading and suggested some longer-term updates to the country's fiscal framework and social safety net but did little to kickstart confidence in a near-term turnaround of momentum. Recent cuts to policy interest rates (with the PBoC focusing increasingly on the 7-day reverse repo rate rather than the Medium-term Lending Facility rate) have been marginal and are unlikely to change the trend of slowing total credit growth (8.1% yoy in June vs 9.5% at the start of the year). Barring new policy announcements, the economy is unlikely to reach this year's government growth target of 5%.

In Belgium, quarter-on-quarter GDP growth came out at 0.2% in the second quarter of 2024 according to the flash estimate, down from 0.3% in the first quarter and slightly below the euro area figure (0.3%). After positive Q1 growth, value added in industry declined again (-0.3%). In construction, in contrast, a negative Q1 figure was followed by positive growth of 1.1% in Q2. The services sector continued to record positive growth (0.2%). With recent disappointing (hard and soft) data on industrial activity, risks to the growth outlook are to the downside. Headline and core inflation were broadly stable at, respectively, 5.5% and 3.3% in July. HICP inflation in Belgium has been running at the highest rate in the EU for the fourth consecutive month now, mainly due the disappearance of the downward impact of previous government measures to ease household energy bills.

According to a preliminary forecast, Czech GDP grew by 0.3% quarter-on-quarter and 0.4% year-on-year in Q2 2024. According to a comment from the Czech statistical office, the economy has been supported by household consumption, while it has been hampered by the continued drawdown of inventories and probably also by relatively weak investment activity, manifested among other things by a weak performance of industry and construction. Over time, the economic performance should be helped by lower inventories, lower interest rates and a gradual take-off in household consumption. We expect a slight acceleration of the recovery in the coming quarters, driven by a slightly better industrial performance. However, given the persistent weakness in recent business sentiment across Europe, the growth outlook is skewed to the downside. Hungary also released its preliminary Q2 GDP growth print. Unlike in Czechia, quarter-on-quarter momentum has weakened there, from 0.7% in Q1 to -0.2% in Q2 (seasonally and calendar adjusted). In year-on-year terms, Hungarian GDP growth also slid down, from 1.6% to 1.3%. Similar to in Czechia, sluggish industrial activity in Hungary had a negative impact on the rate of economic growth.

In line with prevailing expectations, the CNB cut its key interest rate by 25bps to 4.5% on 1 August. All seven board members voted in favour of the decision. The central bank has thus slowed the pace of monetary easing (from 50 basis points in June) and with interest rates closer to neutral, it is now entering the nominal tuning phase. The updated macroeconomic forecast of the CNB slightly revised down the GDP growth outlook for this year from 1.4% to 1.2%, and from 2.7% to 2.8% in 2025. As for inflation, the central bank has not changed its forecast substantially and continues to expect average year-on-year CPI growth at the 2% target next year. The Board now assesses inflation risks as balanced: on the upside, these are increased wage dynamics, inertial inflation in services and, in the longer term, higher credit activity on the property market. The downside risks to inflation are mainly the weaker performance of the domestic and German economies. In the communication following the monetary decision Governor Michl emphasized ongoing caution in the calibration of monetary policy while declining to provide “any indication at all about where rates will go in the future". One can say that the CNB cut rates but played a hawkish card at the same time. Given the favourable inflation outlook and the weak performance of the Czech economy, we continue to expect the CNB to continue cutting rates by 25 basis points. However, the central bank's surprisingly hawkish rhetoric is a risk in the direction of more gradual easing and a possible tactical pause at the end of this year.

A week before the meeting of the CNB, the Hungarian central bank met general expectations and also cut its key interest rate by 25 basis points from 7.0% to 6.75%. The MNB's comments on the decision sounded very moderate, as did the subsequent speech by the central bank's vice-president Barnabas Virag. He said that at each subsequent meeting only two options would be considered: either a 25 basis point cut or leaving rates unchanged. Virag added that bets on the MNB cutting interest rates once or twice more this year (by 25bps) are realistic.

Inflation in Hungary is likely to pick up from the current 3.7% in the second half of the year to 4.5-5.0% by the end of the year. This will lead to a further compression of real interest rates and thus to a de facto easing of monetary policy, without any (downward) movement in nominal official interest rates. This is clearly not considered desirable by the MNB in a situation where the recent high-inflation episode is still relatively fresh and inflation expectations are settled at a relatively high level.

In the end, Fumio Kishida could not escape the pull of gravity.

Japan's ruling Liberal Democratic Party (LDP) will elect its new leader late next month, and in recent weeks, the momentum in Tokyo had been swinging one way: That the unpopular but famously stubborn Kishida would run, and win, as potential successors demurred and bided their time for a better opportunity.

That momentum suddenly ran out Wednesday (Aug 14) when, in the midst of the normally lazy Obon holiday season, the prime minister announced he wouldn't seek another term as LDP head, effectively tendering his resignation and throwing the race for Japan's next leader into chaos.

Parallels are there to be drawn with Joe Biden, the United States president with whom he deepened the bilateral alliance. While the millstones around Kishida's neck are different - his age is not the issue; the controversy is centred on the LDP's funding scandal and ties to the Unification Church - the upshot is the same.

Despite their long list of policy achievements, both leaders struggled to reconnect with the public as they once had, and members further down the ticket began to eye the possibility of a national election, asking how much longer the situation could continue like this.

Like Biden before him, Kishida bowed to polling reality. Yet unlike the US president's swift endorsement of Kamala Harris, there is as yet no heir apparent in Japan.

"We must show a new and changed LDP to the people,"Kishida told reporters on Wednesday. "To do that, we need a transparent, open election and above all, a free and open debate."

Lawmakers and party members will make their choice next month, and with no general election required until October 2025, their selection will determine the country's next leader. (The new prime minister may choose to call a snap national vote, however, as Kishida did.)

It sets the stage for the most interesting leadership vote in the country since the late Shinzo Abe made his shocking return 12 years ago, at a time when the LDP was still in opposition.

During Abe's years in power, he faced little real competition, and when he stepped down due to ill health in 2020, the party quickly rallied around his right-hand man, Yoshihide Suga. Kishida was a logical choice the following year when Suga declined to seek a new mandate.

This time, all bets are off - at least right now. The potential for a left-of-field candidate, perhaps perennial maverick challengers Taro Kono or Shigeru Ishiba, who both have held senior ministerial portfolios, has rarely been higher. Shinjiro Koizumi, the son of the famed rebel Junichiro, might decide his time to run has come at last. Takayuki Kobayashi, a former economic security minister, keeps popping up in media reports.

Support from the party's senior leaders, former prime ministers Taro Aso, Suga, and the incumbent himself, will be crucial.

But with most of the LDP's factions disbanded in the aftermath of the funding scandal, it's hard to know how lawmakers might vote. Up against a weak opposition, the LDP almost always wins national elections.

Whoever succeeds him, Kishida will leave a mixed legacy of both accomplishments and baggage.

His record on defence and foreign policy speaks for itself; it's no coincidence that US Ambassador Rahm Emanuel, Japan's biggest cheerleader, was among the first to issue praise. He hailed the "new era of relations" ushered in over the past three years, and has spoken of how the prime minister could do what his predecessor Abe could not: Double defence spending, relax defence export rules, and restore ties with South Korea, all without sparking mass protests.

With China doves within the LDP a dying breed these days, any successor seems unlikely to rock the boat too much here - though the likes of Sanae Takaichi, currently economic security minister, might move things further right.

But it's at home where things need most attention.

Kishida's "New Capitalism" economic policy was a busted flush, spooking markets and earning him the derisive (and undeserved) nickname of "Tax-Hike Four Eyes." His replacement will need a better focus on the domestic economy.

And he leaves with his promise of salary hikes above inflation only beginning to have impact, with real wages finally rising in June for the first time in 27 months. He should have taken a victory lap on defeating deflation; instead, the public still frets about inflation and the weak yen.

His replacement will have to deal with any further market ructions caused by the rate hikes of Kishida's pick to lead the Bank of Japan, Kazuo Ueda.

With over a month to go, it's entirely possible that rather than air dirty laundry in public, the party will coalesce around a mainstream candidate: Foreign Minister Yoko Kamikawa, perhaps, or policy heavyweight Toshimitsu Motegi.

But potential challengers should take a tip from Kishida, known to be a voracious reader. One of the prime minister's favourite books is reportedly Crime And Punishment. Dostoyevsky writes that "power is only vouchsafed to the man who dares to stoop and pick it up ... one has only to dare".

Ayear has passed since Turkey's government made an important shift in economic policy, followed by additional orthodox monetary steps, and the encouraging results may offer President Recep Tayyip Erdogan a path to retain the presidency for years to come. The question is whether he will ride on a wave of improving economic indicators thanks to modest, short-term policy modifications to seek long-term, constitutional changes that would allow him to remain in power beyond 2028.

In June 2023, after Turkey had suffered five years of extreme inflation, the loss of foreign investment and widening fiscal deficits, a newly appointed minister of treasury and finance set out on a course of textbook policy while the central bank kept raising interest rates. The move has yielded positive results. Given the government's history, however, one question still looms large: Is this policy shift tactical or strategic?

The answer partially hinges on the sustainability of the current policy. It started with foreign diplomats making pronouncements a year ago and now continues with portfolio managers adjusting their holdings. The March 2024 election results, in which the opposition made gains at the expense of support for Mr. Erdogan, further strengthened the policy framework. It may have marked the point of no return from his previous economic moves.

At its outset, the policy shift appeared tactical. The Turkish economy was in shambles, mostly due to serious policy errors from 2018 to 2022. The Turks realized that $5 billion in financing from Saudi Arabia (which Ankara repaid this July) was not going to be enough. It may have been enough for Pakistan for a year, or Egypt for a few months, but for Turkey, $5 billion is barely enough for a day. Turkey is a country with a structural savings deficit. It needs deeper cash flows to keep its economy afloat.

The best way to right the ship was to return to international United States dollar markets, and that could be achieved only by going through the proper channels. That meant putting together a program of reasonable economic policies, as well as a normalization of Turkish foreign policy. In other words, Turkey needed to return to its treaty allies in the West. So, a year ago, that is what Turkey did.

Though the move may sound tactical, it could turn into a strategic decision depending on how Turkey's trading peers react. It takes two to tango. If Turkey finds dancing partners, the process could easily become a strategic shift that improves President Erdogan's popularity and keeps the door open for him to remain in power. Due to term limits stipulating that his current, second term as president concludes in 2028, and in light of his declining public support in recent elections, Mr. Erdogan indicated this March he would respect the current constitution and not seek reelection.

But if the policy shift starts to produce positive results, it could remain in place for quite some time. Developments are moving in that direction. Tighter monetary policy is working. In a series of rate hikes, Turkey's central bank raised the main interest rate from a low of 8.5 percent in June 2023 to 50 percent in March, where it has since remained.

Turks have already started to shift their portfolios from foreign exchange to Turkish liras. The total volume of foreign-exchange-protected Turkish lira accounts has declined despite the currency's weakness, which was a time bomb built during the “irrational” policy years. Foreign investors are now also following the lead of their Turkish peers and shifting to lira-denominated assets. The central bank has started to accumulate its own reserves of U.S. dollars, decreasing reserves borrowed through swap agreements. That further improved the effectiveness of monetary policy decisions.

Inflation peaked at around 75 percent this May, moved a touch lower to 71 percent in June and is expected to decline to roughly 40 percent by year-end, according to the Turkish Central Bank's forecast from May.

Budget deficit projections at Turkish economic research organization TEPAV have also declined from 8.3 percent of gross domestic product (GDP) to 6.9 percent. In line with medium-term program expectations. The improvement is due to the government's initial fiscal policy measures and rapidly rising prices; inflation helps fiscal policy by nominally increasing tax revenues. Nevertheless, even a deficit of 5 percent of GDP is too high for Turkey, and market observers are expecting a second fiscal policy package to boost tax revenues beyond the impact of rising inflation.

A year after the policy shift started, Turkey's risk premium has declined to 255.8 basis points from a high of 800 in the previous policy era. While that looks impressive, the current premium is still too high to pay in foreign exchange borrowing.

Early positive policy results tend to turn the tactical into the strategic. Can President Erdogan go back to his earlier unorthodox, irrational policies after achieving a reasonable level of economic stability? No, he cannot and he will not. There are several reasons why.

First, even if inflation does fall to about 40 percent by the end of the year as hoped, Turkey would remain among the top 10 highest-inflation countries. By that indicator, Turkey may not be faring as poorly as Venezuela, but it is on par with South Sudan and Sierra Leone. There is hope that the policy changes will push inflation down to around 15 percent in late 2025, putting Turkey somewhere between the Democratic Republic of the Congo and Yemen. Any hope of achieving a figure in the single digits is possible only if the economy remains stable and monetary policy is credible. Mr. Erdogan simply cannot afford any more mistakes. Any backsliding can once again lead to expectations that inflation will start rising again, driving the risk premium higher and preventing any anticipated monetary easing.

Second, in municipal council elections in March 2024, Mr. Erdogan's Justice and Development Party (AKP) party garnered just under 30 percent, compared to 36 percent in general elections in May 2023 and 43 percent in 2018. The steady decline in support is a result of the rising cost of living and bleak economic outlook.

This reflects that while headline inflation may continue to decline, lowering the total cost of living and making life bearable for the lower to middle classes requires more than price-stabilization policies. Improving their quality of life requires a new growth and job-creation strategy for the country. In turn, that requires decarbonization plans, education reform, rule of law measures and resolving the operational problems of Turkish courts. Achieving such reforms could lead to a boost in foreign direct investments, which have become negligible in recent years.

Third, the modernization of Turkey's customs union framework with the European Union can provide a structural reform agenda, coupled with a new growth agenda for the country. However, for customs union modernization to start, Turkey has to convincingly make its claim that joining the EU (accession negotiations stalled in 2016) is a strategic priority by taking measures to enhance democracy and the rule of law.

Banxico's latest rate decision was always going to be a close call. Markets and economists alike were split on whether policymakers would keep rates unchanged or resume the easing cycle. In a 3-2 split vote, policymakers opted to restart the rate cutting cycle by delivering 25 bps of easing, lowering the overnight rate to 10.75%. The official statement highlighted that policymakers are most concerned with slowing economic prospects. Indeed, Mexico's economy has demonstrated signs of deceleration over the course of this year, which, combined with a slowing U.S. economy, means growth prospects in Mexico are under a bit of pressure (Figure 1). Also, policymakers revealed that while headline inflation risks are still tilted to the upside, core inflation is tame and contained enough to warrant easier monetary policy. In a mild surprise, at least to us, Banxico barely mentioned Mexican peso depreciation and volatility nor did voting members indicate any form of concern related to political risks either domestic or external. We interpret Banxico forward guidance to mean additional rate cuts are on the way; however, we got the impression that policymakers will still approach monetary policy decisions with a degree of caution. In that sense, despite our base case being that the Federal Reserve delivers back-to-back 50 bps rate cuts starting in September, we believe Mexico's central bank, at least for the time being, will lower interest rates by 25 bps at each meeting through the end of this year. Our revised Banxico outlook now means we forecast Mexico's policy rate to fall to 10.00% by the end of this year. We also believe policymakers will ease monetary policy further in 2025, and now forecast a year-end 2025 policy rate of 8.00% (Figure 2). As far as risks to our Banxico forecast, risks are tilted toward more aggressive easing, especially if the Fed does indeed deliver the 50 bps cuts we forecast or Mexico's economy decelerates more quickly than we expect.

With the path for Banxico monetary policy now clearer, financial markets are likely to shift focus toward political developments. Mexico's political backdrop has been unsettled following elections in June; however, in the coming weeks we will get clarity on the political appetite for amending Mexico's constitution and for fiscal consolidation. Newly elected congress members will take office next month and overlap with incumbent President AMLO during the last month of his term. Technically, AMLO's MORENA does not have a congressional supermajority, falling three seats short in the senate; however, congress members have been known to support policies outside their party's agenda in an effort to seek concessions for other political agenda items. Should opposition policymakers support constitutional amendment proposals, MORENA would likely be able to cobble together enough support in both houses of congress to adjust Mexico's constitution. With that said, even if MORENA does reach across the aisle and get support from opposition policymakers, MORENA policymakers themselves would still have to vote in favor of amendments. In 2018, MORENA won a supermajority under AMLO and many of AMLO's policies that required amending Mexico's constitution were voted down in congress. Mexico's political dynamics can still evolve in a variety of ways, and we will get insight into the direction of political risk and Mexico's governance backdrop in the coming weeks. Mexico will also have to submit a budget for 2025 in the near future. As of now, the government is running a relatively wide fiscal deficit of ~5% of GDP. On the campaign trail Sheinbaum preached fiscal consolidation and responsibility; however, since winning the presidency she has commented on expanding welfarism and social spending. Deficit targets have also been widened with Sheinbaum recently referring to a 2025 fiscal deficit of ~3.5% of GDP, up from the 3% target mentioned during her campaign.

While the possibility of weaker institutions and a wider fiscal deficit are concerning, we believe Mexico will avoid worst-case scenarios on both fronts. In short, our view comes down to the idea that Mexico has too much to lose by moving forward with constitutional amendments that disrupt the governance framework and by not exercising fiscal discipline. Since the pandemic, Mexico has gained headway as the preeminent nearshoring destination for corporations shifting operations closer to the United States. Reconfiguring legal frameworks, democratic workings, as well as Mexico's checks and balances system risks disrupting nearshoring-related investment and the economic benefits of supply chains landing in Mexico. Some other drivers of Mexico's economic growth have dwindled over the years as Pemex oil production has declined sharply and political uncertainty in the United States has become more prevalent. At a time when a new avenue for growth is needed, we have our doubts Mexico's policymakers would jeopardize the economic growth nearshoring could generate. Also, constitutional amendments, in combination with wider fiscal deficits, puts Mexico's investment grade credit rating at risk. Losing investment grade status could result in forced selling of sovereign debt and broader capital outflows that could lead to financial instability. From a political perspective, Sheinbaum as well as MORENA could see damaged credibility as policymakers by losing the coveted investment grade rating, risking the longer-term perception of MORENA and future presidential candidates. In our view, these are risks the new political leadership will ultimately be unwilling to take. We believe cooler heads will prevail, political risk will simmer to pre-election levels, and fiscal consolidation will be eventually pursued.

While challenges for the Mexican peso are present from multiple angles, we continue to believe the Mexican peso can experience a recovery and strengthen over the long term. For most of the last few years the Mexican peso has been a notable outperformer relative to the U.S. dollar. That trend was upended as a result of elections in June, and the peso has recently experienced renewed depreciation pressures due to the global unwind of the FX carry trade following the Bank of Japan's rate hike and concerns that the U.S. Federal Reserve is behind the curve on pivoting to interest rate cuts. But, while political and carry trade risks may linger for the time being, we believe the Mexican peso is still a fundamentally sound currency that can experience long-term strength. On the local politics front, we believe our “cooler heads prevail” scenario can be the initial catalyst for a peso recovery. If policy continuity manifests itself, as opposed to a weakening of Mexico's institutions via constitutional reforms, a lessening of political risk can improve sentiment toward the Mexican peso. At the same time, a shift back toward fiscal responsibility can support Mexico's investment grade credit rating and prevent rating agencies from taking a more negative view on Mexico's rating trajectory. A combination of reduced political risk and increased fiscal responsibility can be, in our view, key drivers of the Mexican peso's long-term strengthening trend against the U.S. dollar. In addition, we continue to believe the U.S. dollar is set to embark on a period of cyclical depreciation against many foreign currencies, including the Mexican peso. With the U.S. economy decelerating, but likely to achieve a “soft landing”, and the Fed ready to shift to more accommodative monetary policy, the combination of more robust growth abroad and lower U.S. interest rates should support global risk sentiment. As risk sentiment improves, demand for safe haven currencies such as the dollar should fade, improving prospects forthe Mexican peso. Finally, despite an easing bias from Banxico, policy rates in Mexico relative to the U.S. should remain attractive. With U.S. rates on track to move lower, a “search for yield” dynamic may unfold across financial markets. As mentioned, carry trade risks may persist to some extent, but the peso is still likely to be associated with a healthy degree of carry that can act as a supportive factor for the peso over the longer-term. We will provide a forecast profile for the USD/MXN exchange rate in our August International Economic Outlook, but as of now, we can say the long-term view for the peso is one where the currency strengthens over the course of 2025.

We would also be remiss to not mention the risks to our Mexican peso outlook that stem from the upcoming U.S. presidential election. Yes, the long-term outlook for the peso can be challenged by an adverse U.S. policy mix following the outcome of this year's election. Should U.S. policy toward Mexico be defined by stricter border control, tariffs and harsher trade terms, Mexico's real economy could be damaged and sentiment toward the peso could suffer. This scenario is perhaps more likely under former President Trump as opposed to Kamala Harris; however, we are not, at this time, convinced a second Trump term will materially disrupt the long-term peso trend. We say this for a few reasons. First, should former President Trump win in November, his victory would not be a surprise the same way his win was in 2016. The peso responded particularly poorly to Trump's win in 2016 largely due to the shock factor. This time around, while the election remains a close call as of mid-August, a Trump victory would not be a shock reminiscent of 2016. Second, should Trump win the election he will not have to worry about being re-elected in 2028 or beyond. A win this year terms out Trump, which in our view, at least introduces the idea that he will not be as driven to keep playing to his base of supporters with populist-style and hawkish rhetoric. Two sides to this argument certainly exist, but without a need to reinforce support from his base, Trump may gravitate more toward the center of the political spectrum rather than move further right. And finally, the USMCA trade agreement is up for review in 2026. A theory exists that Trump can use the USMCA review process to secure concessions on immigration and border control with Mexico. Keep in mind Trump negotiated the USMCA, and if he were to seek modifications, there would be some degree of public acknowledgement of flaws in the original trade deal. We have our doubts as to whether Trump would admit to flaws in a deal he negotiated and his administration ratified. For these reasons, and for the time being, we continue to forecast a stronger Mexican peso regardless of who wins the U.S. presidency this year. That said, if the U.S. policy mix does in fact turn more aggressive toward Mexico, our assumptions would have to be reconsidered and our long-term peso view would likely change.

For years, the sheer size of China's economy made it an irresistible magnet for foreign investors, with many – including sovereign wealth funds from the Gulf – contemplating larger allocations to the country.

China's economy, generating more than $10 trillion annually, has consistently outpaced the growth rates of western counterparts, including the US. However, recent trends reveal a shift in sentiment among foreign investors, particularly those operating within China.

Once seen as a top region for investment, China's allure is fading, with concerns about internal support for domestic companies and declining profitability for foreign ones.

As a result, foreign investment is increasingly gravitating towards select services sectors, leaving China's manufacturing industry, once the engine of its economic miracle, struggling to attract new entrants.

A recent European Chamber of Commerce poll paints a bleak picture of foreign business confidence in China. The 2024 Business Confidence Survey found the percentage of companies ranking China as a top investment destination has hit record lows – 15 per cent for current investments and only 12 per cent for the future.

Many companies are now redirecting investments originally planned for China to other markets perceived as more stable and transparent. Those foreign subsidiaries in China that want to expand find it harder to convince their headquarters to allow them to do so, the survey found.

However, the latest IMD World Competitiveness Ranking paints a different picture. It found that while Singapore is the most competitive economy, China is closing the gap, having leapt seven places in the table thanks to its strong post-pandemic recovery.

China now ranks 14th, up from 21st last year. Among countries with populations of 20 million or more, China is now the fourth most competitive economy.

However, when it comes to its attractiveness to foreign investors, the country fell seven places to 11th. Clearly, a large economy isn't enough to sway investors.

Data on foreign direct investment (FDI) into China isn't promising either.

The UN data shows total FDI into China fell $25 billion in 2023 to $163 billion. From 2019 to 2023, the UN estimates total net inflows amounted to $681 billion. That may sound impressive but it pales in comparison to the total value of foreign corporate investments in China. That figure rose to $1.89 trillion over the same time period.

This increase could mean one of two things: either the value of the installed base of investments went up a lot, or most of the foreign expansion in China was funded by foreign companies that were already there. Either way, the figures will cast doubt on China's ability to widen its appeal to new foreign entrants.

Realised FDI (the value of investments that actually occurred) in its manufacturing sector peaked in 2022 at some $57 billion. For the previous decade, the annual totals of realised manufacturing FDI, according to Chinese official figures, never exceeded $50 billion.

Moreover, the number of newly established foreign goods producers in China fell to its lowest level in 2022 at 4,608 firms – half the level seen in 2012 and a fifth of that witnessed in 2005.

If more first-time investors were being attracted to China as a production base – possibly as an export platform – then surely the number of new foreign firms should be rising, not falling.

China's reputation as the “workshop of the world” makes the decline in manufacturing FDI particularly striking.

Instead, most foreign investment is now flowing to the service sector. Remarkably, every year since 2010, the total value of realised FDI in Chinese services has exceeded that of the country's factories.

While 26.3 per cent of all realised FDI into China in 2022 was in the manufacturing sector, 12.6 per cent was in IT, another 16 per cent in research and development services, and 17.5 per cent in leasing and business services. In 2022, $131 billion was invested in foreign services, leading to the creation of more than 33,000 new service sector companies with foreign owners.

These outcomes are not in synch with Beijing's aim to promote manufacturing over services, focusing on high-tech and strategic industries to boost economic growth and self-sufficiency. Despite the government's emphasis on boosting manufacturing, foreign investors continue to focus more on the service sector. One reason for this mismatch is that foreign industrial firms operating in China have seen their profits grow slower than their Chinese peers, according to official data.

From 2014 to 2017, the profits of foreign industrial firms rose in line with Chinese peers. Then up to the pandemic in 2020, foreign firm profitability plateaued while Chinese industrial firms increased their earnings – creating a performance gap.

Although foreign companies saw a jump in profitability in 2021, Chinese firms experienced similar gains. After that, profits for foreign industrial firms declined more sharply than those of their Chinese counterparts, widening the performance gap. Despite some recovery in foreign firm profitability in the first half of this year, the gap remains significant.

Such findings will fuel claims that, since the mid-2010s, Chinese policies have increasingly favoured domestic firms over foreign rivals. It's natural to expect Chinese firms to gradually catch up with their foreign competitors, as they improve their capabilities.

However, the consistent progress of Chinese firms year after year doesn't fully explain the significant and sudden decline in the profit performance of foreign industrial firms operating in China, especially since 2017 and after 2021.

So long as suspicions linger that the Chinese government is tilting the commercial playing field in favour of local industrial firms, then this will dampen the allure of investing in the Chinese manufacturing sector. For the time being, what remains alluring to investors are certain high-profile Chinese service sectors, including the geopolitically sensitive IT sector.

While China's economy remains a global powerhouse, its fading appeal to foreign investors, particularly in manufacturing, reflects deeper concerns about market predictability and fairness. As foreign investors weigh their options, China may need to reassess its strategies to maintain its position as a leading destination for global investment.

The yen edged up against the dollar on Friday but looked on course for its biggest weekly decline since June after a slew of U.S. economic data eased fears of a recession and supported bets of gradual easing of monetary policy by the Federal Reserve.

The dollar was softer against the yen USDJPY at 148.73, but hovered close to Thursday's high of 149.40, a level last seen on Aug. 2.

Risk-sensitive currencies such as sterling were firm as the improved economic outlook spurred a rally in equities.

Data on Thursday showed the number of Americans filing new applications for unemployment benefits dropped to a one month-low last week and U.S. retail sales increased by the most in 1-1/2 years in July, dashing expectations that the Fed could cut interest rates by a super-sized 50 basis points (bps) next month.

"We are in the camp that thinks growth slowdown is there, inflation is slowing and the Fed will start cutting rates but it's not going to be a panic situation, which was turning into a narrative a week or two ago," said Salman Ahmed, global head of macro and strategic asset allocation at Fidelity International.

"We remain of the view that we'll see 2-3 cuts, very likely two rather than three unless the increase unemployment rate that we saw in the last payrolls report sustains."

Traders are convinced the Fed will slash rates on Sept. 18, but had debated the size of the reduction after surprisingly soft U.S. payrolls data had pushed the odds of the larger 50 basis-point cut to 71% in early August.

Odds for such a move currently stand at 28%, down from 36% a day earlier, according to the CME Group's FedWatch Tool.

The dollar index DXY, which measures the greenback against six major peers, eased 0.2% to 102.84 as of 0830 GMT.

The Japanese yen has continued to draw eyes, and with losses of about 1.4%, the currency was on track for its biggest weekly drop since in almost two months.

The move was almost as dramatic as its surge to as strong as 141.675 yen per dollar on Aug. 5 as the Bank of Japan's surprise rate hike, combined with the flare-up in U.S. recession worries, sparked an aggressive unwinding of yen-financed carry trades.

Some calm was restored after influential BOJ deputy governor Shinichi Uchida said the central bank would not hike rates when markets are volatile, and there are signs traders have been rebuilding short positions.

"There's a lot of room for (carry trades) to be wound up again. Uchida's (dovish) guidance was quite strong. Foreign investors are going to take this as a dip-buying opportunity in dollar-yen," Shoki Omori, chief Japan desk strategist at Mizuho Securities, said.

Official data shows plenty of flows are happening, and Japanese investors ploughed the most money into long-term overseas bonds in 12 weeks in the week to Aug. 10, while foreigners net bought short-term Japanese debt after eight straight weeks of net sales.

Overseas investors also snapped up about $3.5 billion in Japanese shares, reversing three consecutive weeks of net selling.

Sterling GBPUSD rose 0.2% to $1.2886 - its highest since July 29 - on the back of positive economic data. The currency was on track for a 1% weekly rise, its best performance in more than a month.

British retail sales edged up in July, boosted in part by extra spending due to the men's Euros soccer championship, official figures showed, after an unusually cool and wet June had kept shoppers away.

The euro EURUSD added 0.1% to $1.0987. The common currency touched its highest level since Jan. 3 earlier this week, helped by drop in the dollar after soft data.