USDLong-term US bond yields may remain very volatile in light of today’s US jobs data announcement. Such volatility is still important for FX, but payrolls’ implications for Fed pricing are more consequential for the dollar in the long run. Keep an eye out for important reports on the Canadian labor market: The fate of a raise by the Bank of Canada in September is uncertain.
Dollar: Should We Reconsider Fed Pricing Again?
Yesterday, US bonds were still under selling pressure from the triple-whammy of strong US activity indicators, rising supply, and the aftermath of Fitch’s downgrade. It does seem like an unusual set of circumstances has created a bearish pocket, and skepticism regarding the longevity of the sell-off is warranted. We don’t see this as a sustainable basis for a sustained dollar upswing.
Bond market volatility may have distracted traders from yesterday’s ISM service data. While the headline survey dropped by less than expected (52.7), it is still in expansionary zone. However, the employment component slowed significantly, falling from 53.1 to 50.7. Even without looking at the other surveys, we can see that the ISM manufacturing employment gauge is at its lowest level in three years, and that the odds are slightly skewed toward a softish result in non-farm payrolls today. Since the ADP numbers haven’t shown any ability to predict official employment data, this scenario seems unlikely. Recent data support the consensus estimate of 200k jobs added, but joblessness could rise somewhat. The Federal Reserve is likely to focus extensively on wage growth this month.
The dollar has strengthened, notably against higher-beta currencies, as a result of the downgrade of the US sovereign credit and the subsequent increase in long-dated US yields. For the reasons stated above, the dollar’s near- and medium-term outlook continues to be highly dependent on Fed views, which have not changed despite the current bond selloff. Markets are pricing in almost no likelihood of further raises (8bp) and putting the first rate decrease in May 2024 as we head into today’s NFP announcement.
As a result, unexpected NFP prints should cause sizable directional changes in USD crosses. The market is currently positioned to allow for significant repricing in either direction (pricing in a rise before year’s end, moving forward the first reduction). Also, the longer end of the yield curve is expected to move rather substantially after the announcement, and this higher volatility will remain a risk for FX today. While fiscal and bond supply variables have an impact in the short-term, hard data are what investors will be left with in the long-term.
New Zealand dollars and Canadian dollars are two currencies we’re keeping an eye on because they’ve become cheaper in this risk-off rout. Having already factored in the dovish shift of the Reserve Bank of New Zealand (RBNZ), weak domestic statistics, and China’s economic pessimism, the former appears to be nearing the limit of the negatives it can absorb. We do not rule out the possibility that the RBNZ would need to re-consider tightening on the back of a resurgence in inflation later in the year, and a stabilization in mood and restoration of demand for carry trades could provide some breathing room for the high-yielding NZD.
Important employment data for Canada is due out today, and it could tip the scales in favor of a rate increase in September. We would not be surprised by a stronger print than the expected 25k increase in jobs, which is less than half of the 60k increase in June. With wage growth expected to pick up steam, the markets may be persuaded to price in one final rate hike in September (at present, 8bp is priced in).
Stabilizing Euro
In line with a broader unwinding of safe-haven positions, the EUR/USD has found some support overnight after its drop halted around 1.0910 yesterday. While the euro fared better than higher-beta currencies during the bond market’s peak volatility, it will have less room to recover once bond market pressure eases.
Today’s EUR/USD movement will be solely influenced by US jobs data and any further fluctuations in treasury rates, given the Eurozone economic calendar is extremely quiet. If the data comes in lower than expected, the pair might rise to 1.100, but if it comes in higher than predicted, it could fall to the next important supports at 1.0900 and 1.0850.
BoE’s hawkish 25bp rate increase for the pound
Yesterday’s policy decision from the Bank of England was rather unsurprising due to the positive inflation surprise. As a result of a decline in the pound prior to the meeting and the hawkish message linked to the 25bp hike, the currency was mostly unchanged following the announcement.
Two MPC members voted for a 50bp hike, while one voted to keep rates unchanged, as discussed in our BoE meeting review note. Assuming the Bank rate is not increased any more in the following months, the latest prediction from the Bank suggests that inflation is likely to return to target by 2025.
Markets are presently wagering that 5.75% will be the peak rate, and the BoE is keeping the door wide open for further tightening. Since inflationary pressures appear to be easing, our economics team expects another 25bp increase to 5.50% in September. This suggests that Cable still has a chance to trade above 1.30 in the fourth quarter, despite our expectation that the dollar will decrease towards the end of the year.
Czech Koruna: CNB formally ceased FX Intervention regime
The Czech National Bank left interest rates unchanged yesterday, as had been widely anticipated. The decision announcement itself was the biggest shocker though, as it formally ended the FX promise. The board decided it was no longer essential to bring up the potential of FX intervention, despite the fact that the charges were still quite high and the Czech National Bank (CNB) had last interfered in October of last year.
The governor reaffirmed later in the press conference that the central bank can intervene at any time because the Czech koruna is under a managed float regime. The central bank has also resumed its plan of selling foreign exchange reserve proceeds in an effort to slow the expansion of its balance sheet, which has been called into question in the past and is seen as a legacy of the previous board.
The market should not noticeably be affected by the fact that monthly volumes under this initiative have reached €100-200m in the past. It appears the Board wants to test the market prior to the actual rate drop and possibly work off some monetary easing before the actual rate cut, notwithstanding the governor’s reiteration that FX remained an essential tool in the fight against inflation. We are sticking with our original projection of a November cutoff.
Given the unexpected move by the central bank, the Czech koruna’s reaction in the foreign exchange market—a spike to 24.20 EUR/CZK—seems relatively muted. So while today’s depreciation is to be expected, it’s unclear whether or not the central bank is actively selling FX reserve proceeds, so preventing a dramatic devaluation. The governor had no interest in making a statement on the matter, as it would not bode well for the CNB. As a result, we anticipate more koruna selling pressure today and would not rule out a fresh rally to 24.30-40 EUR/CZK to re-evaluate recent market highs.
