FX Update: Bar is high for negative US payrolls surprise

The most curious market development yesterday was the quick recovery in risk sentiment from the very weak US ISM Non-manufacturing survey reading for September at 52.6, a number that re-establishes the trend showing a deceleration in the expansion of the US services sector since the beginning of the year. The employment sub-component was a very weak 50.4, the weakest reading since an odd one-off dip in early 2014. I’m holding off judgment on the narrative, but either the bounce was down to the major averages nearing key technical levels (most notably the 200-day moving average in the S&P 500, which was 15 points below yesterday’s low, but the 40-week moving average was touched during yesterday’s session) or the market wants to celebrate an accelerated Fed easing schedule that arrives with bad data, including importantly hopes that Fed balance sheet expansion will arrive more quickly and in bigger size to provision the market with plenty of liquidity.

In FX, the weak US data combined with a bounce-back in risk sentiment saw the USD weakness broadening out to more than it likely would have had risk sentiment remained on the defensive. The USD outlook is increasingly pivotal as break-down levels near in a number of key pairs. Already, USDJPY has crossed below the important 107.00 level, while EURUSD and other pairs have more heavy lifting to do to suggest a more profound turn in the greenback’s fortunes.

Some may suppose, as we have seen in the past, that there is some “Goldilocks” level of weakness in the data – sufficiently weak data to point to rapidly rising Fed efforts to bring further easing, but data not so weak as to suggest a profound reassessment of risky asset valuation or blow out credit spreads. But I don’t buy into that argument and recent developments don’t look so promising on that front, as high yield credit spreads have widened aggressively this week – the Barclays index I track has risen to 420 bps wide of treasuries, from lows below 360 bps last month. The highs over the last several months are just below 450 bps, while the high during the late 2018 episode of market volatility and the Fed’s policy mistake was north of 500 bps.

All told, today’s payrolls release comes amidst an interesting set-up for both market technical and in terms of the market narrative. Most surprising would be a positive print, while to really surprise to the downside, we may need to see a print south of +50k together with chunky negative revisions to the prior two months’ data.

Chart: USDJPY weekly
USDJPY has broken down through the 107.00 area, exposing the range lows into 105.00 and below, an important area going back several months. Risk off and weaker global yields in the wake of negative US data are traditionally negative for the pair, and usually the bond market weighs more heavily than risk sentiment in the equation – note for example, yesterday’s bond rally has stuck despite the equity market rebound, just as USDJPY has remained relatively heavy.