US employment report comes in hot, dashing hopes of a Fed pause
Dollar races higher, equities slip, but yen is surprisingly resilient
Aussie hits new lows after soft Chinese data, crucial week lies ahead
Despite a relentless rally in interest rates this year that was meant to cool demand, the US labor market continues to fire on all cylinders. Nonfarm payrolls clocked in at 263k in September, a slowdown from last month but still a solid reading overall. Most importantly, the unemployment rate fell back to a five-decade low, dispelling speculation that the Fed is about to pause its tightening cycle.
While several leading indicators such as housing, inventories, and business surveys suggest the American economic engine is losing steam, this hasn’t been reflected in the ‘hard’ data yet. The jobs market is exceptionally tight, inflation is still running at four times the Fed’s target, and economic growth fired up in the third quarter according to the GDPNow model.
The resilience of the real economy provides the Fed with the perfect cover to keep raising rates until inflation is clearly simmering down. Markets have almost fully priced in another 75bps rate hike for next month, and the upcoming US inflation report on Thursday could add the finishing touches.
As for the dollar, the elements that fueled the stunning rally are still present. Rate differentials continue to widen in its favor and other major currencies are grappling with their own demons - the euro with energy shortages, sterling with irresponsible politics, the yen with monetary policy divergence, and the antipodeans with China’s property meltdown.
However, the risk-reward profile of chasing further dollar strength from here doesn’t seem very attractive. The market is loaded with long-dollar bets, so even though the fundamentals still favor a stronger greenback, the trade is crowded and the runway for more gains limited. That sets up an asymmetric situation moving forward, where strong US data generates only minor rallies in the already-powerful dollar, but soft numbers can spark serious declines.
The reserve currency outperformed most of its competitors after the employment report, aside from the Canadian dollar, which enjoyed a double boost from its own jobs data and the comeback in oil prices.
Dollar/yen was another oddity. It pierced back above the battleground region of 145.00, but only barely so. The yen’s durability in the face of soaring global yields is strange, and suggests either that demand for the currency as a hedge is picking up thanks to the mayhem in equity markets or that the Bank of Japan is active in stealth mode inside the FX market, trying to smoothen the depreciation path.
Aussie and stocks sink
A sense of gloom carried over into the new week, following the latest data from China. The Caixin services PMI fell back into contraction in September, fueling concerns that the breakdown in real estate has started to infect the broader economy, which was already reeling from strict lockdowns. The Australian dollar suffered collateral damage, sinking to fresh post-pandemic lows.
Meanwhile, Wall Street came under heavy fire after nonfarm payrolls shattered the notion of a Fed pivot anytime soon. The Nasdaq lost 3.8% and futures point to more selling today, ahead of a crucial earnings season that kicks off later this week.
Overall, it’s still too early to be optimistic on stocks. Valuations have corrected but remain far too expensive for these levels of interest rates, quantitative tightening is running at full speed, and the economic slowdown in Europe and China adds credence to worries about margin compressions leading to earnings downgrades. The wild card is the US midterm elections in one month, which have a historical tendency to spread cheer in the market.
Finally, geopolitics have flared up again with Ukraine attacking a bridge that was vital to the Russian war effort, and the Kremlin responding with missile strikes on cities including the capital of Kyiv.