Dollar romp continues as US labour report smashes expectations
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The relentless dollar rally continued for yet another week, fuelled by sharply higher bond yields in the US and signs that the world’s largest economy is, yet again, gaining momentum.
Australian Dollar (AUD)
Once again, the Australian dollar printed near the bottom of the G10 FX performance tracker last week. Sentiment towards the currency has taken a turn for the worse since the December RBA meeting, in which policymakers signalled to markets that lower domestic rates may not be as far off as initially expected. The big question now for market participants is whether or not the bank will pull the trigger at its next meeting in February, or wait until later in the year. We see nothing as yet set in stone, and RBA officials will be pouring over upcoming economic reports to help guide their decision. Front and centre this week will be the December labour market data on Thursday. An easing in job creation and a modest uptick in the unemployment rate are expected, with any downside surprises likely to raise the risk of a February rate reduction. January PMI data (next week), and the Q4 inflation report (29/01) will also be very closely monitored by policymakers.
New Zealand Dollar (NZD)
The New Zealand dollar has traded in lockstep with its Australian counterpart in the past month, with both of the Antipodean currencies underperforming all of their major peers. The heavy exposure of both countries to Chinese demand is becoming increasingly troublesome given Trump’s pending tariffs. This adds to an already gloomy outlook for the New Zealand economy, which is now stuck in recession following the downright disastrous Q3 GDP report. Market participants will have little economic news to go off in the next few days, although we will be keeping tabs on the latest business activity PMI data on Thursday. Another print well below the key level of 50 is expected.
USD
The US payrolls report for December was very strong, confirming that the Federal Reserve will struggle to find justifications for any further cuts, at least for the time being. In fact, markets are now pricing in just one 25bp rate reduction for the whole of 2025 that, in practical terms, probably rounds down to no cuts at all. After the very poor performance of US fixed income markets generally, this week’s CPI report will be key. Economists are expecting the monthly core index to ease from 3-4% annualised levels, where it has printed for the past four months, to a more Fed-friendly 2-2.5%. Failure to do so may reignite turmoil in the US bond market, which already has to deal with the prospect of a wall of supply caused by a ballooning fiscal deficit. The key for the FX market will be the point at which this Treasury sell-off becomes a negative for the dollar, rather than a positive, as has already happened in the UK – we are not quite there yet.
Chinese Yuan (CNY)
The recent jump in the USD/CNY exchange rate above the key 7.30 mark has raised questions over the extent of China’s willingness to support the currency. Considering a barrage of actions and signals from the central bank in recent days, it seems that, at least for now, policymakers remain committed to preventing sharp declines in the exchange rate. The CNY fixings have been firm, PBOC rhetoric suggests determination to counter market-disrupting actions, bond purchases have been paused and the central bank plans to mop up offshore yuan liquidity using a record bill auction in Hong Kong. This leaves little doubt that the central bank is intent on stabilising the exchange rate. Meanwhile, inflation slowed in December to just 0.1%, further pointing to soft domestic demand. This week’s myriad of releases will help to get a better reading of the state of the economy at year-end, with trade numbers, fourth-quarter GDP and monthly data dump all coming up. The yuan’s fate in the coming days will partly depend on whether we see signs of a turn for the better.
Japanese Yen (JPY)
The yen has made a fairly solid start to the year so far, and currently sits only behind the US and Canadian dollars in the G10 pecking order. We think that this relatively decent showing can be partly attributed to valuation, while investors are solidifying their bets in favour of higher Bank of Japan rates in 2025. While the December BoJ announcement provided nothing but further disappointment for yen bulls, there remains a broad consensus that higher rates are on the way, with a total of 50 basis points of hikes now seen by year-end. Swap markets see around a 50/50 chance of another rate increase in January, although the close proximity of the meeting to president-elect Trump’s inauguration suggests that we may have to wait until March. Communications from the bank’s Deputy Governor Himino will be closely watched this week, with investors eagerly awaiting any clues that could pertain to the prospect and timing of additional hikes.
GBP
While the violence of the moves in the gilt market did not match what we saw in 2022 after the Liz Truss mini-budget, a 25bp sell-off in merely a week where no major economic or policy news was released is still a remarkable downdraft. The pound reacted poorly to the turmoil, falling against all of its European peers by 1% or more. This appears to be a delayed negative reaction to the details of the Autumn Budget, as investors fret over the impact of the government’s fiscal measures on the state of public finances and the economy. We think that the backdrop for sterling is significantly better than it was after the Truss budget disaster: higher Bank of England rates are supportive, and there are credible prospects for a better relationship with the EU on trade, which investors clearly see as bullish for the UK currency. However, it appears increasingly necessary for Labour to deliver spending cuts in order to fully stabilise the UK sovereign bond market, which remains vulnerable to any negative surprises in inflation.
EUR
The euro had another difficult week against the dollar, driven down by higher Treasury yields and yet another strong payrolls report in the US. We will point out, however, that the rate increase in the Eurozone bond markets almost matched the move in the US, and that the yield gap has actually been narrowing for some weeks, which should be supportive of the common currency. Indeed, macroeconomic news out of the bloc last week was mildly upbeat, notably the latest unemployment data and revised PMI figures, which provides reason for very cautious optimism towards the Euro Area economy. Core inflation in the Eurozone remains stuck at an annual rate of 2.7%, however, where it has been for the last four months, and ECB members will be closely monitoring the recent uptick in the main measure of inflation, which is back at its highest level since July. With the yield headwinds abating, and the currency at an undeniably cheap level, we think even marginally positive news out of the Eurozone would help stabilise the common currency.