Weekly FX Chartbook: Focus Shifting Back to Rate Cuts

Additionally, Macron cannot call for another election to resolve the impasse for at least a year, leaving no immediate solution if the political deadlock continues. As negotiations for forming a coalition proceed, markets may react negatively to the uncertainty, although the stronger-than-expected performance of Macron's bloc may help contain some fallout. Overall, this outcome extends the period of uncertainty. While the EUR might experience a brief relief rally due to the avoidance of a far-right victory by Le Pen, this is likely to be short-lived. The medium-term challenges for the EUR have intensified, particularly when considering additional risks from the upcoming US elections.

USD: US Data Weakness Broadening Out

The June jobs report shows that non-farm payrolls rose by 206,000, slightly above the consensus of 190,000. However, there were significant downward revisions to the previous two months, resulting in 111,000 fewer jobs than initially reported. This indicates a clear cooling in job creation, with the 3-month moving average now at its weakest since January 2021. Additionally, the unemployment rate has risen above 4%, reaching 4.1%, compared to 3.4% in April last year. This increase in unemployment suggests that slack is forming in the labor market, which is keeping a lid on wage growth. Average hourly earnings increased by 0.3% month-on-month and 3.9% year-on-year, the slowest annual increase since Q2 2021.

The details of the jobs report reveal that private sector job creation is particularly weak, given that private payrolls increased by only 136,000 in June, compared to +193,000 in May. This is more reflective of true economic conditions, while government job changes are relatively more volatile.

The Federal Reserve is likely to view this report as consistent with their “soft landing” narrative. The economy is still adding jobs, but at a slower pace. The rising unemployment rate is an indication that slack is forming, which could cool wage growth, and keep inflation on track to reach the 2% target. The Fed aims to avoid causing a recession and would prefer to shift policy from restrictive to “slightly less” restrictive if the data allows. September is now a potential time for the first Fed rate cut, and expectations for this will increase further if core CPI meets the expected 0.2% month-on-month this week. For now, the market is attaching about 80% odds of the first Fed rate cut in September, and pricing in two full rate cuts for this year.

This week’s focus will be on Fed Chair Powell’s testimony to the Senate (Tuesday) and the House (Wednesday). He is expected to reiterate his recent remarks that where he said that the disinflation trend is showing signs of resuming, and that they are getting back on the disinflationary path. In his earlier comments, Powell had also stated that any unexpected weakness in the labour market could prompt the Fed to react. Any further comments on this or a take on the weakness in June NFP could trigger dovish signals to the market.

In summary, the US dollar is taking a turn lower and was down 1% last week as Treasury yields slipped on data misses from ISM services to non-farm payrolls. As the US exceptionalism fades further, there may be room for a further pullback in the US dollar, however French election concerns could provide a temporary offset. Focus will also shift further to the US elections as we get towards the latter part of Q3, which suggests any slide in US dollar could open the possibility of a safe-haven bid. As noted in our Q3 outlook, we remain only mildly bearish on the US dollar despite the Fed policy turn.

GBP: Focus to turn back to BOE

The Labour Party has won a landslide victory in the UK general election, as expected. While a change of government and that too with a majority vote could fuel policy support optimism, there is little fiscal room in the UK for that. As such, the near-term impact from the election may be immaterial. Markets will return to focus on Bank of England’s policy direction, and on the radar will be some speeches this week which return after the quiet period ahead of elections. Chief Economist Huw Pill and Catherine Mann will be speaking on Wednesday.

Governor Andrew Bailey has been hinting at summer rate cuts. If further conviction is seen on this in BOE commentaries, markets could increase the odds of an August BOE rate cut, which for now is priced in with less than 70% probability. The risk is a potentially weaker US data leading to relatively more aggressive Fed rate cuts weakening the US dollar, or sustained political uncertainty in Europe weighing on EUR and pushing safe-haven flows into sterling.

NZD: RBNZ Likely to Stay Neutral

The Reserve Bank of New Zealand (RBNZ) will conduct its latest Monetary Policy Review this week. The central bank is expected to maintain the Official Cash Rate (OCR) at the current level of 5.50%. Money markets are pricing in a 95% chance for the OCR to remain unchanged and just a 5% probability of a 25bps cut.

In its previous meeting in May, the RBNZ kept the OCR unchanged in what was seen as a hawkish hold. The central bank raised its OCR forecasts across the projection horizon, suggesting a push-back in the timing of the first cut to late 2025. It maintained its hawkish language, emphasizing the need for restrictive monetary policy and expecting consumer price inflation to return to the 1%-3% target range by the end of 2024. However, RBNZ Governor Orr’s comments since the May meeting have lacked the same hawkishness. Since there have been limited economic releases since the last meeting, there may be scope for the RBNZ to remain patient this week.

While a weaker US dollar could spell some gains for the Kiwi dollar (NZD), economic weakness concerns in New Zealand may limit the upside. Meanwhile, AUDNZD remains poised for further upside given there may be room for the hawkishness of the Reserve Bank of Australia to outlast RBNZ.

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Recent FX articles and podcasts:

• 3 Jul: Yuan vs. Yen vs. Franc: Shifting Carry Trade Strategies
• 2 Jul: Quarterly Outlook: Risk-on currencies to surge against havens
• 26 Jun: AUD, CAD: Inflation Rising, Can Central Banks Stay on Pause?
• 21 Jun: JPY: Three-Way Pressure Piling Up
• 20 Jun: CNH: China Authorities Loosening their Grip, But Devaluation Unlikely
• 19 Jun: CHF: Temporary Haven Flows Unlikely to Fuel SNB Rate Cut
• 18 Jun: GBP: UK CPI Details and Elections Will Keep BOE on Hold
• 13 Jun: BOJ Preview: Tapering and Rate Hike Talk Not Enough to Boost JPY
• 10 Jun: EUR: Election jitters and ECB rate cut add to downside pressures  

Recent Macro articles and podcasts:

• 4 Jul: Special Podcast: Quarterly Outlook - Sandcastle economics
• 1 Jul: Macro Podcast: Politics are taking over macro
• 28 Jun: UK Elections: Markets May Be Too Complacent
• 24 Jun: Macro Podcast: Is it time to diversify your portfolio?
• 12 Jun: France Election Turmoil: European Equities Amidst the Upheaval
• 11 Jun: US CPI and Fed Previews: Delays, but Dovish
• 10 Jun: Macro Podcast: Nonfarm payroll shatters expectations - how will the Fed react?
• 3 Jun: Macro Podcast: It is a rate cut week

Weekly FX Chartbooks:

• 1 Jul: Weekly FX Chartbook: Politics Still the Key Theme in Markets
• 24 Jun: Weekly FX Chartbook: US Presidential Debate is the Big Market Unknown
• 10 Jun: Weekly FX Chartbook: US CPI and FOMC dot plot have a low dovish bar
• 3 Jun: Weekly FX Chartbook: ECB and Bank of Canada likely to cut rates

FX 101 Series:

• 15 May: Understanding carry trades in the forex market
• 19 Apr: Using FX for portfolio diversification
• 28 Feb: Navigating Japanese equities: Strategies for hedging JPY exposure
• 8 Feb: FX 101: USD Smile and portfolio impacts from King Dollar