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US dollar braces for nonfarm payrolls test


7 January 2022 Written by Anthony Charalambous  XM Investment Analyst Anthony Charalambous

The main event today will be the US employment report for December, which could be huge for the dollar and equities as rate traders are currently pricing in an 80% chance for the Fed to begin its hiking cycle in March. Nonfarm payrolls are forecast to have risen by 400k, pushing the unemployment rate down one tick to 4.1%. Markets are likely positioned for an even stronger report after the private ADP report clocked in at an impressive 807k. Another encouraging sign is that jobless claims fell substantially during the NFP survey week from a month ago. 

Conflicting signs for US jobs

That said, other labor market indicators were not so optimistic. The Markit PMI surveys showed that “employment growth slowed to only a marginal pace” while the ISM services report also hinted at a slowdown in job creation. These allow scope for disappointment, especially in light of Omicron. 

In the markets, a nonfarm payrolls number around 400k could take some air out of Fed bets and deal a minor blow to the dollar, although it would not be a game-changer. In contrast, stock markets could react positively to a slight disappointment, as we are in the stage where bad news is good news for equities. Beyond the initial reaction, what could decide the direction in the markets is wage growth, given the implications for inflation. 

FX and equity arenas calm

The currency market has been rather quiet in recent sessions. The dollar traded sideways for most of the week despite the revelations in the Fed minutes, where the central bank opened the door for shrinking its balance sheet at a faster clip than the previous normalization cycle. 

This means the Fed will allow maturing bonds to roll off its balance sheet, effectively sucking liquidity out of the financial system. Along with intensifying speculation for a rate increase in March, this helped lift Treasury yields quite substantially. 

It is therefore striking that the dollar hasn’t rocketed higher, even though rate differentials have widened in its favor against the euro for instance. This may reflect some caution ahead of today’s jobs data, with traders waiting for the risk event to pass before raising their exposure to the reserve currency.  The Fed’s balance sheet reduction plans are equally important for equities. Let’s not forget that this strategy ultimately broke the stock market back in late 2018, forcing the Fed to reverse course and cut rates multiple times to calm nerves. On the bright side, this is a risk for the longer term. 

Gold and oil go their separate ways

In the commodity sphere, gold prices suffered another drop yesterday. The untold story of this week was that real rates shot much higher, with the US 10-year inflation-protected yield reaching a six-month high. 

Real yields are arguably the most important driver of gold, so it’s almost a miracle the metal didn’t get hit even harder. One element behind gold’s relative resilience may be geopolitical tensions, which have intensified lately with protests in Kazakhstan turning bloody. 

These tensions may be what helped oil prices defy the gloomy mood in the markets this week, as Kazakhstan is a major crude producer. It is still unclear how much output will be lost, but oil traders seem to be in a ‘shoot first, ask questions later’ mode for now.

By XM.com
#source

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