US Tariffs Take Effect, Fed Minutes Support Gradual Hikes, US Jobs Report Under the Microscope
The dollar traded lower against most its G10 counterparts yesterday. It gained only against JPY, while it traded virtually unchanged against GBP and CHF. The main gainers against the US currency were NOK, NZD and SEK, in that order.
The safe-haven yen remained on the back foot, while riskier currencies like AUD and NZD outperformed the greenback, even after the US tariffs on USD 34 bn worth of Chinese goods took effect overnight. Shortly after the US decision, China responded with a statement saying that it was forced to retaliated, which means that tariffs at the same rate and on the same dollar-amount of US goods would be imposed. Besides the FX reactions suggesting a risk-on mood after the tariffs, Asian equity indices and futures on other markets across the world rose. Nikkei ended its trading session around 1.2% up.
In our view, this was a classic “sell the rumor, buy the fact” reaction. The markets have already responded to the proposal of these tariffs back in April. In mid-June, when the US finally decided on the matter and China responded, markets remained somewhat indifferent, but they took a hit a few days later on Trump’s fresh threats. The pattern suggests market participants discount the measures well before they come into effect. Thus, for fears and anxiety to surge again, we may need to get new threats or unplanned actions. In other words, something that investors haven’t noted on their agendas.
Yesterday, the FOMC published the minutes from its latest policy meeting, when it raised interest rates by 25bps, and the new “dot plot” pointed to two more hikes by the end of the year, instead of just one as the previous one suggested. In the minutes, it was noted that members expected that further gradual rate increases “would be consistent with sustained expansion of economic activity, strong labor market conditions, and inflation near the Committee’s symmetric 2 percent objective over the medium term”. Many also noted that “if gradual increases in the target range for the federal funds rate continued, the federal funds rate could be at or above their estimates of its neutral level sometime next year”. That said, officials also expressed concerns over trade policies saying that uncertainty surrounding the matter has intensified and could have a negative effect on business sentiment and investment spending.
Yesterday, we noted that we will scan the minutes for any discussion on how close rates are to their neutral level, and what this means for policymakers’ future plans. The main message we got from the minutes is that policymakers are willing to continue hiking rates this year and the next, and that they could allow rates to rise above neutral for some time. As for the concerns around trade policy, it was something to be expected, we believe.
The dollar did not react much at the time of the release, but according to the Fed funds futures, the implied probability for the Fed to end 2018 with a total of 4 quarter-point rate increases has risen to fractionally above 49% from near 46% yesterday.
As for today, USD-traders are likely to turn their gaze to the US employment report for June. The forecast suggests that non-farm payrolls increased 200k, after rising 223k the previous month. Yesterday, the ADP report showed that the private sector gained 177k jobs, which may have raised some speculation that the NFP number may also come below its forecast. However, we have to repeat for the umpteenth time that the correlation between the two time-series at the time of the release (no revisions are taken into account) has fallen in recent years. Taking into consideration data from January 2011, the correlation stands at around 0.45. The unemployment is forecast to have held steady to its 18-year low of 3.8%, while average hourly earnings are expected to have risen at the same monthly pace as in June (+0.3% mom). Without any revisions to previous monthly rates, this could drive the yoy up to +2.8% from +2.7% as the monthly print of June 2017 that will drop out of the yearly calculation was +0.2%.
Overall, the forecasts suggest that we are likely to get a strong report, consistent with further tightening in the labor market. Although the initial market response may come from the NFP number, barring any major deviations from the forecast, the aftermath direction is likely to be dictated by the yoy earnings rate. Accelerating wages mean more spending and thereby higher inflation in the foreseeable future, something that could lead the Fed to faster rate increases.
Therefore, a higher earnings rate could strengthen even further the case for two more Fed hikes by year end and thereby, bring the greenback under buying interest. On the other hand, a disappointment in wages could pour cold water on expectations that the Fed will end the 2018 with a total of 4 hikes and the dollar could tumble.
USD/JPY – Technical Outlook
We area seeing mixed trading this week in USD/JPY, but today’s US jobs data may help traders decide on at least a short-term direction. After moving back down from this week’s highs of 111.150, the pair rebounded from near 110.25, to break above 110.55. Also, one thing to point out is that USD/JPY is trading above the short-term upwards moving support line, taken from the low of 29th of May. For now, we remain neutral, as this could play out both ways, due to the US jobs number today.
If the data comes out on the positive side, USD/JPY could spike north and get closer to this week’s high at 111.15. If the bulls maintain their momentum and manage to drive the battle above that level, then we could see them driving the pair all the way to the 111.40 zone, marked by the high of the 21st of May.
The RSI is just slightly above the 50 line but points sideways. The MACD is also flat, not giving us any clear indication.
On the downside, if we see a move below 110.55, then we could expect USD/JPY to go lower and test the 110.25 area, marked by Wednesday’s low. The catalyst for such a slide could be a disappointment in today’s employment figures. Further depreciation in the rate could lead to a test of the 109.95 zone and at the same time the aforementioned upside support line. A break of that line could invite more bears into the game and could open the path towards the 109.70 level or even the 109.35 hurdle, marked by the low of the 25th of June.
BoE Governor Carney Boosts August-hike Expectations, But Brexit Uncertainty Weighs
Given that GBP/USD traded virtually unchanged on Thursday, the pound traded in a similar fashion as its US counterpart against the other G10 currencies. It gained only against JPY, while it lost the most versus NOK, NZD and SEK in that order.
During the European morning Thursday, the pound spiked north following remarks by BoE Governor Carney, who noted that “the incoming data have given me greater confidence that the softness of UK activity in the first quarter was largely due to the weather, not the economic climate.” He also noted that household interest rate expectations of a rate increase this year are reasonable and that officials would have enough information to make a decision on rates in August, despite not having initial growth figures to work with, due to the new ONS schedule. Yesterday we noted the first estimate of the UK GDP was to be released on the 26th of July. That’s the old schedule. According to the new one, the figures will be published on the 10th of August, after the BoE meeting which is scheduled for the 2nd of the month.
Following the latest PMI data, and especially the rise in the all-important services index on Wednesday, Carney’s remarks may have prompted market participants to increase their bets with regards to a hike at the Bank’s upcoming gathering. However, as we noted yesterday, we still have a lot to get before that meeting. Although we won’t get official GDP data, the NIESR GDP estimate for June will be released on the 10th of July, while on the 17th, 18th and 19th of the month, we get employment, inflation and retail sales data respectively.
Back to the pound, its rally did not last for long. The currency erased the Carney-related gains after the German government described Theresa May’s custom plan as “unworkable”. The UK Prime Minister traveled to Berlin yesterday for talks with Merkel on her pan. Today, PM May meets with her senior ministers in a try to reach common ground on the UK’s trade relationship with the EU after Brexit. Up until now, May’s advisors have come up with two proposals, but none of them gained the full support of her party. This is their third attempt, and with the clock ticking towards the 29th of March, the official date of the UK’s departure from the EU, another failure to agree on the matter could further increase investors’ anxiety over Brexit and could add more pressure to the pound. Now, in case ministers indeed agree, the pound is likely to gain, but we would stay skeptical with regards to sustained gains, as the UK government would still have to win the support of the EU, something that appears to be a hard task for now.
As for the Rest of Today’s Events
Besides the US jobs report, we get employment data from Canada as well. The unemployment rate is forecast to have held steady at its four-decade low of 5.8% for the fifth consecutive month, while the net change in employment is anticipated to show that the economy added 24.0k jobs, after losing 7.5k in May. Despite the disappointment in Canada’s CPI for May and retail sales for April, hawkish remarks by BoC Governor Poloz last week kept the market overwhelmed with regards to the prospect of a July rate hike, and a decent employment report could strengthen further the case. Canada’s trade data for May and the Ivey PMI for June are also coming out.
GBP/CAD – Technical Outlook
It looks like GBP/CAD is waiting for a big move, as for now, the pair keeps trading within a range, between 1.7440 and 1.7305. In the bigger picture, the rate continues to trade above the long-term upside line, drawn from the low of the 8th of September 2017. There is also a slightly more shorter-term upside support line that also should be mentioned, which is taken from the low of the 31st of May and is still in play. Both lines remain intact for now, but one should remain cautious, as GBP/CAD could challenge them both soon if we get good economic numbers from Canada today. For now, we will remain slightly positive, but we keep monitoring the aforementioned range that GBP/CAD is still within.
If the pair gets closer to the upper bound of the range and manages to break it, this could open the door towards the 1.7550 level, which could act as the next potential resistance line. Further acceleration in the rate could lead GBP/CAD to 1.7620, the break of which could make the bulls more confident and drive the pair to the 1.7705 zone for a quick test.
Alternatively, a break below the short-term upside support line mentioned before, could force GBP/CAD to test the lower side of the range, a break of which could interest the bears to take the rate lower. A good potential area of support to keep an eye on is the 1.7255, which is also not far from the other longer-term upside support line, which could stall the pair from dropping further. If, eventually, the break of that support line happens, then we could aim for the 1.7180 support zone.
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