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FX Update: Bottom drops out of USD on odd ISM Services shock.

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John Hardy

Head of FX Strategy

Summary:  The market marked the US dollar down several notches on a particularly weak December ISM Services survey, with the negative impact partially enhanced by softer than expected earnings growth in the December jobs report. The reaction looks excessive for a single data point, and other US employment data remains strong. Elsewhere, the market continues to scramble to absorb the implications of China’s massive policy pivot, as China’s currency soars and the Aussie hangs on to its coattails.

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FX Trading focus: Mixed jobs report, weak ISM services spike the greenback. Market scrambles to absorb massive China policy pivot

The US December jobs report was a mixed bag, with payrolls growth approximately in-line with expectations after revisions, while average hourly earnings came in at a weak +0.3% MoM/+4.6% YoY vs. 0.4%/5.0% expected. That year-on-year print was the lowest since August of 2021. Still, the Household survey used to calculate the unemployment rate was very strong after a string of weak months, sending the unemployment rate back to the cycle low of 3.5% even after a +0.1% rise in the participation rate. Then the ISM Services reading for December shocked with a plunge to 49.6 versus 55.0 expected and 56.5 in November. The New Orders sub-index dropped nearly 11 points to 45.2. It was ugly, but it is also just a single data point and one that looks almost too bad to be true relative to normal shifts in the data series, suddenly dropping out of the ex-pandemic range of the last 10 years for the worst reading since 2009 (again ignoring the three worst pandemic affected months in 2020.) This at least two standard deviation-negative ISM Services survey surprise and the weak Average Hourly Earnings data are soft data points in the very area the Fed has identified as the troublesome area that can potentially drive inflation, so not surprising to see a significant reaction in US treasury yields, with the 2-year benchmark yield dropping 20 basis points and the 10-year around 15 basis points. The USD was thrown overboard as risk sentiment improved, and the pro-cyclical currencies fared best, as discussed with the AUDUSD chart below.

Market scrambles to price China policy pivot. The pivot in China’s policy has been breathtaking over the last month, a full 180-degree shift on domestic restrictions on activity due to Zero Covid was already in place weeks ago, but the more recent signals have more significance for the longer term, including the opening of borders as of yesterday and a string of moves to support the property market. While China’s activity levels could remain limited in the near term on the current Covid outbreak, the market is scrambling to price in the medium term and longer implications of what has unfolded here – metals prices have jumped and the Chinese yuan has gone almost vertical against a weaker US dollar and is the strongest among G10 currencies since last November.

Among G10 currencies, the Aussie has rallied the hardest, in part on the recent signaling from China that it is set to resume coal imports. Australia’s mining giant BHP Billiton opened strongly overnight and nearly closed at an all time high in AUD terms. But a measure of caution is needed here. The property sector in China absorbed malinvestment on an epic scale over the last twenty years and was a key engine of China’s growth, many multiples as a percent of GDP than anything the US ever saw during its housing bubble. Redoubling malinvestment in an already bloated sector is possible on some scale, but not good policy. The bigger effort in the property sector is to sort out the balance sheet mess for investment values that are out of touch with any real economic utility of housing. In other words, how does China deleverage this sector is a more urgent policy question. So, this policy shift in China has certainly improved the global economic outlook relative to the former business as usual, but a full scale stimulus move is not likely in the cards. In other words, the China reopening trade is already looking a bit rich before the actual post-Covid reality has even started to shape up. AUDUSD is an excellent barometer, together perhaps with the copper price, for the China-growth-hope trade.

AUDUSD has rushed higher on the combination of weak US data triggering a slide in US yields and the greenback, while the massive policy pivot in China, together with the sharply stronger currency and solid response in key commodity markets has revived hopes for the Australian outlook, even if it hasn’t revived RBA expectations. AUDUSD cleared very notable levels since Friday – first the pivot high just below 0.6900 from back in December, but more significantly the 200-day moving average for the first time since last April. Today’s close looks important on the freshness of this break for arguing the bull case of a sustained break of 0.7000. If the pair limps back into the range below perhaps 0.6850-00 and stays there after this Thursday’s US CPI release, it would suggest a false break, likely on overenthusiasm on the coming impact of China’s policy shift.

Source: Saxo Group

Table: FX Board of G10 and CNH trend evolution and strength.
China tops the leaderboard on its recent policy pivot, with the AUD hanging onto its coattails. Despite yields falling sharply in the US on Friday’s US data releases, JPY crosses were less impressed as the solid comeback in risk sentiment held back the yen.

Source: Bloomberg and Saxo Group

Table: FX Board Trend Scoreboard for individual pairs.
Note that AUDJPY is the first JPY cross already trying to flip out of downtrend, together with CNHJPY as risk sentiment has posted a rebound and on hopes for a global commodities rebound as China opens up. Elsewhere, the USD is rolling over again in places (NZDUSD) and threatening to do so (USDSEK, USDNOK), while EURUSD has yet to breach the cycle resistance.

Source: Bloomberg and Saxo Group

Upcoming Economic Calendar Highlights

  • 1000 – Eurozone Nov. Unemployment Rate
  • 1200 – Mexico Dec. CPI
  • 1330 – Canada Nov. Building Permits
  • 1530 – UK Bank of England Chief Economist Huw Pill to speak
  • 1730 – US Fed’s Bostic (non-voter) to speak
  • 1730 – US Fed’s Daly (non-voter) to speak
  • 2000 – US Nov. Consumer Credit
  • 2330 – Japan Dec. Tokyo CPI

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