Macro/FX Watch: Dollar momentum weakens on NFP miss

USD: Momentum and positioning point to further downside, but..

Markets saw a sharp turnaround last week. This shift in sentiment started when the Treasury’s refunding announcement came in lower than expected and alleviated some concerns around supply as an ongoing technical headwind. That was followed by a dovish interpretation of the FOMC meeting by the markets and the final push came from jobs data on Friday which missed expectations and signalled that the labor market is starting to loosen as high interest rates penetrate. Headline non-farm payrolls rose 150k (prev. 297k revised down from 336k) shy of the expected 180k. Meanwhile the unemployment rate ticked higher to 3.9% (prev. & exp. 3.8%) and wages rose 0.2% M/M (prev. & exp. 0.3%) and 4.1% Y/Y (prev. 4.3%, exp. 4.0%).

Bad news is good news, and the miss in jobs have prompted markets to bring forward the Fed rate cut expectations to June from July earlier, which is boosting risk assets. Santa rally appears to have started early this year, and seasonality trends could mean more upside for risk assets as markets finally get the much-awaited Fed pivot. Along with a stretched long dollar positioning, this turn in momentum could bring more dollar downside. But are there any credible alternatives to the dollar? We believe the dollar downside could remain limited for the following reasons:

1. The Fed’s recent turn to a less hawkish stance came from hopes of long-end yields substituting for a rate hike. But if long-end yields start to drop then it will open the door more another Fed rate hike or tweaks to QT. Fed speakers this week will likely try to keep a hawkish posture to allow the long end yields to do their job and avoid premature loosening of financial conditions
2. Weaker US exceptionalism story cannot prompt growth optimism across the Atlantic. While ECB’s Lagarde has recently sounded committed to bring inflation back to target levels, EURUSD’s move to 1.07+ levels will be tested this week with EZ activity data, ECB inflation expectations and Fitch’s rating of Italy. China’s economic woes will also continue to be highlighted by weak export data as well as deflation risks back on the horizon
3. Stagflation concerns have been highlighted again with headline ISM services falling to 51.8 from 53.6, and beneath the expected 53.0 but the prices paid components showing signs of an upswing again. This means higher-for-longer can still prevail.
4. Bank of Japan’s move last week to allow 10-year yields to rise above 1% remains subtle and Governor Ueda was back on the wires today trying to manage expectations around the exit from negative rates and reaffirmed dovishness, which will keep JPY attractive as a funding currency for carry trades
5. Geopolitical risks remain as Israel is expanding its operations in Gaza and market is currently discounting any risks of a regional escalation. But if things turn for the worse, USD could see a safe-haven bid once again

Market Takeaway: Downside pressure on USD could go further as risk assets are boosted by hopes of end of the Fed’s tightening cycle, but there is still no alternative to the dollar. USD could remain range-bound until we see a more material weakness in US economic data.

AUD: High stakes for the RBA announcement

The RBA announcement tomorrow remains a close call. Economists are calling for a rate hike but market is pricing only 50% odds. RBA has noted earlier that tolerance for inflation overshooting target is low, and Q3 CPI numbers thereafter came in above expectations. However, Governor Bullock was quick to temper her hawkishness post-CPI, saying that the CPI jump was as expected. Meanwhile, house prices continue to soar and retail sales have surged recently. This has prompted markets to expect another rate hike from the RBA.

While we think that growth concerns warrant a pause, but the expectations that have been built up in the run up to tomorrow’s meeting suggesting that there is considerable room for disappointment if the RBA did not hike rates. The mid-way would be perhaps to hike by 15bps rather than the usual increment of 25bps if RBA wants to maintain its credibility.

China trade and inflation data also due in the week could continue to signal the fragility of the recovery in the Chinese economy and continue to be a headwind for AUD. Also, if Fed speakers in the week come out in strong support of higher-for-longer to avoid the long-end yields from undoing the job of tightening for them, then that could also blow another headwind to AUD.

Market Takeaway: AUDUSD could test 50DMA at 0.6395 if the RBA failed to follow-through on a rate hike as credibility comes in question.