USD had an up day as US yields moved modestly higher and risk-on sentiment improved. The Spanish situation calmed down somewhat after Spain's Constitutional Court ordered Catalonia’s Parliament to suspend its planned session on independence. US factory orders beat estimates, while durable goods orders were revised higher.
Hawkish comments from both SF Fed President Williams and Philadelphia Fed President Harker also helped the dollar. The market doesn’t believe the FOMC’s forecasts for rates as set out in their quarterly “dot plot,” but the Committee members seem to be sticking to them – indicating to me that at some point the market will have to readjust its views and push the dollar higher.
That won’t necessarily happen today, though. The outlook for the dollar today will of course depend on the payroll data, particularly the average earnings, in my view. I think the risk is that average earnings fail to impress and USD weakens (see below).
EUR by contrast was hit by some dovish remarks in the minutes of the ECB’s latest meeting. The ECB Council agreed that “(a)ny reassessment of the monetary policy stance should proceed in a very gradual and cautious manner, while maintaining sufficient flexibility.” The members also expressed “discomfort” about how much longer they expected inflation to remain below their target levels. The debate within the Council seems to be more about the pace at which they taper down their bond purchases rather than the date by which they terminate the purchases completely. That would suggest rates are likely to remain lower for longer than many people had expected and is therefore negative for EUR.
GBP was the big mover. It continued to fall as PM Theresa May’s future, never that certain, became even less certain. Her disastrous performance Wednesday at the Tory Party Conference has increased the likelihood that she has to step down at some point, throwing the confused UK political situation into even more chaos even as the Brexit deadline approaches inexorably. I remain steadfastly negative on GBP.
AUD was also lower on press reports that RBA board member Ian Harper said a rate cut was possible if consumption continues to slow. AUD too seems likely to depreciate further as the economy there searches for new supports, in my view.
The European day starts early with German factory orders. They’re expected to have bounced back in August, but not enough to keep the year-on-year rate of increase stable. This is a reminder of the recent contrast between the “hard” data, such as this figure, and the “soft” data, such as surveys like the Ifo business survey and purchasing managers’ index (PMI). The Ifo indicated a rise in manufacturing order books during the month, while the PMI also rose substantially. If it becomes clear that those surveys may be exaggerating the strength of Germany’s economy, it could be negative for the euro.
Britain’s Halifax Building Society’s index of house prices is expected to be unchanged from the previous month, but higher on a year-on-year basis. This may be because the year-on-year rate of change is actually a three-month moving average, and the 0.9% mom decline in June is now dropping out. Also as often happens there are different sets of data: there are seven estimates for the mom rate of change and nine for the yoy. I would tend to think that no increase in prices from the previous month would be a negative sign, especially after the Nationwide Building Society showed a +0.2% mom rise, and would therefore be negative for the pound.
After that, the market will probably settle down and wait for the US nonfarm payrolls. The official “consensus” forecast is 80k, but as I mentioned earlier in the week, there’s fantastic uncertainty about this – the standard deviation of the estimates is 40k, with people guessing anywhere from -45k to +153k. By comparison, the standard deviation was only 16k and 15k in the previous two months.
Despite the uncertainty, Wednesday’s ADP report hit estimates exactly at 135k. This has made some people think the figure won’t be as bad as they might have thought, and the “whisper” number – a Bloomberg survey of whoever has a Bloomberg terminal and wants to submit their view – is 120k. This indicates that the market thinks the risk is a figure higher than economists expect, probably because the NFPs have been fairly steady at close to 180k for many months now.
Given the distortions, the market may instead choose to put less emphasis on the NFP number and instead focus more on other parts of the report. The unemployment rate is expected to hold steady at 4.4%, which is below what the Fed thinks is a non-inflationary rate. That would be bullish for the dollar. The average workweek is also expected to be unchanged, which would be neutral.
The focus outside the NFP number itself is likely to be the average hourly earnings. Earlier in the week the consensus was for earnings growth to accelerate, which would’ve been quite positive for the dollar, but now the median forecast is for the year-on-year rate of growth to remain unchanged for the sixth month in a row. `
The average earnings figure is quite significant, because the Fed desperately wants to see the tighter labor market feeding through to higher wages. But if it turns out that there’s still no change, and indeed the month-on-month rate of growth is continuing at a weak pace, then the dollar could come under some selling pressure, in my view.
At the same time as the US employment data is coming out, the Canadian employment data will also be released. The figures are expected to be mixed: the unemployment rate remaining at the lowest since the financial crisis of 2008, which is good, but only a modest increase in employment during the month, which is not so good. I think the figures are likely to be neutral for the CAD. The currency implications could be tipped one way or the other by the figure for wage growth, which is not forecast. If wage growth accelerates, that could prove encouraging for the Bank of Canada, just as it would for the Fed. Late in the day there are a number of Fed speakers. The most important one is clearly New York Fed President William Dudley, who will speak on “The Monetary Policy Outlook and the Important of Higher Education for Economic Mobility.” Of course it’s the first half of that title that the markets will be interested in. Dudley is on the dovish side, but he’s been arguing in favor of gradual tightening for some time. He said recently that the Fed “will likely continue to remove monetary policy accommodation gradually.” In other words, he’s still OK with a rate hike in December. But that was before the core personal consumption expenditure deflator (PCE) for August was announced, showing that the Fed’s targeted inflation gauge is actually slowing. Does he still expect to hit the Fed’s 2% inflation target “over the medium term”? Stay tuned!
This article comprises the personal view and opinion of the STO Investment Research Desk and at no time should be construed as Investment Advice.