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FX Watch: Soft landing narrative, as long as it lasts, can slow bullish dollar bets
Charu Chanana
Stratégiste des Marchés
Résumé: US nonfarm payrolls boosted hopes of a US soft-landing and Fed rate hike bets continue to be pared. This could setup for a near-term downside in the US dollar until weakening economic momentum prompts Fed rate cut bets later in the year. While yen and yuan could be the biggest beneficiaries of the slowing dollar upmove, these could be expensive to short the dollar due to the carry. AUD could extend upside if China sentiment continues to be repaired and RBA leaves the door open for tightening vs. Bank of Canada which has little scope to go for a hawkish hold. Gold is also making a fresh attempt to break higher.
US Nonfarm Payroll: Headline job growth masks underlying weaker messages
The US nonfarm payrolls increased by 187k in August, coming in above the 170k expected. But the last two months saw a net downward revision of -110k, suggesting data remains prone to downward revisions. The unemployment rate edged up to 3.8% from 3.5% in July and wage growth moderated with average hourly earnings growth of 4.3% YoY slowing from July’s 4.4%. The downward revisions in prior months’ data have erased any scope of a hawkish surprise coming from the headline print. Also, slowing wages and the increase in unemployment rate, although still modest, is also another sign of loosening in the labor market, leaving little scope for the markets to expect any more rate hikes from the Fed.
The household survey, which is used to calculate the unemployment rate, shows that an increase in labor force was one of the key factors driving the increase in number of unemployed persons. The labor force increased by 736k as per this survey, with 222k gain in the number of employed, resulting in 514k gain in the number of unemployed. This meant labor force participation jumped to 62.8% from 62.1% a year ago, and this should also help to keep wage pressures in check. Worth noting however, that increased labor force participation can suggest dwindling household cash balances as pandemic savings start to run out – another signal that consumer spending could be constrained in Q4.
Soft-landing narrative can slow the dollar rally
Data over the next few weeks, including this week’s ISM services print for August, will likely continue to support the case for no further rate hikes from the Fed. However, Q3 data will still be supported by one-off spending items such as entertainment spending, and unlikely to show a marked deterioration in economic momentum for now. This means soft-landing hopes could continue to gain traction for now, which could be bearish for the dollar. Deeper recession or stagflation concerns, or a safety bid for the dollar, will have to wait for more evidence of a downturn in the US economy. Central bank narrative, meanwhile, will also shift towards the scope of rate cuts from the potential for more rate hikes. Growth differentials, therefore, could be a key driver in the next phase of the cycle.
Emerging markets have been the first movers in the easing cycle, with Chile and Brazil having announced rate cuts. However, the rate cut path may remain slow, despite a hefty start, amid Fed’s higher-for-longer message. Historically, the Fed is quicker and more aggressive to cut rates and that also leaves the dollar prone to some downside. The sticky core inflation issue in the UK and Eurozone suggest that BOE and ECB will likely work with a lag in the easing cycle, although how quickly economic data in Europe and UK turns sour will have to be on watch. Also, dollar’s carry advantage continues to offset concerns of a decline, but gold upside is likely as Fed pause expectations get entrenched.
Market Takeaway: The USD bias is shifting to neutral/negative in the short run as soft-landing hopes are bolstered. Fed usually leads in an easing cycle, further suggesting scope for some short-term pressure on dollar. XAUUSD stands to gain if Treasury yields slide further.
Central banks of Australia and Canada meet this week, China stimulus remains key
Canada’s Q2 GDP unexpectedly fell by 0.2% QoQ, falling well below the central bank’s expectation of 1.5% gain, and suggesting that the risks for the Bank of Canada meeting this week may be titled dovish and support for the CAD may be tough to come by even if oil prices continue to rise.
Australia’s July CPI slid below 5% for the first time since early 2022, and July labor data was also weaker-than-expected. This has strengthened the case for a pause from the Reserve Bank of Australia (RBA) at Tuesday’s meeting. But the RBA may still need to leave the door open at this week’s meeting for some more tightening amid risks of another spike in CPI later in the year. AUD may remain supported with a hawkish hold, as long as the positive risk sentiment continues and further focus from China on supporting the yuan and its economy.
Market Takeaway: AUDUSD needs to close above 0.6522 triple top and break above 0.6640 is key for a clearer uptrend. USDCAD could continue to rise towards 1.3650. AUDCAD could see upside risks on central bank divergence in the week and target 0.264 retracement at 0.8844 in the short-run.
Yen could be expensive for a dollar short
If near-term yields continue to go lower as Fed rate hike bets are pared, that could be a setup for a recovery in the Japanese yen. Lack of upside momentum in USDJPY above 145, despite no signs of verbal intervention, indicates that traders are wary of intervention risks. Meanwhile, speculation is rife for another tweak at the September Bank of Japan meeting after sluggish demand at the 2-year auction last week. Focus this week will also be on the auctions for 10 and 30-year Japanese government bonds (JGBs), and lower demand could signal that market participants are staying on the sidelines in anticipation of rising yields.
Government reports have also been suggesting progress on exit from deflation and Japan’s output gap, a measure of demand and supply, turned positive for the first time since Q3 2019 as per the Cabinet Office report on Friday, suggesting demand is outstripping supply. These inputs continue to fuel further speculation of a BOJ tweak in September. While that could bring a breathing room for the yen, cost of carry still remains a key issue for USDJPY bears.
Market Takeaway: Unwinding of Fed rate hike expectations opens scope for a yen recovery. Close below 144.50 in USDJPY could lead to a larger correction down to the 0.618 retracement and support at around 141.55. For more technical levels in JPY pairs, see here.
China measures could support CNH and AUD
China’s PBoC announced a 2%-pt cut in reserve requirement ratio for foreign currency deposits (FX RRR) to 4% effective September 15. While this could help to slow the slide in yuan, it may not be enough to reverse the path given the risks around China’s debt and property sector. There are some signs of a turnaround in China sentiment in the short run, from stimulus measure being touted to be “too little, too late” earlier to now indicating a clear commitment to prop up the economy and the yuan. China’s Caixin manufacturing PMI also returned to expansion in August, and data this week could show a surge in loan growth.