USD continues to trade on stronger footing in run up to NFP report

USD: Improving US cyclical momentum providing support

The US dollar has continued to trade at stronger levels ahead of the release tomorrow of the latest nonfarm payrolls report for December. After failing to break below support at the 98.000-level at the end of last month, the dollar index has risen back to within touching distance of the 200-day moving average at 98.856. The stronger US dollar was encouraged yesterday by the release of the ISM services survey revealing business confidence jumped to its highest level since October 2024 prior to the election victory for President Trump. Business confidence in the services sector has increased for three consecutive months signalling improving cyclical momentum for the US economy heading into this year. The break down revealed that the improvement was driven by a 5.0 point increase in the new orders while the employment sub-component also moved back above the 50.0-level to a ten month high of 52.0 in December.

However, the positive signal for the US labour market was partially offset by evidence of continued weakness provided by the releases of the latest ADP and JOLTS surveys. The ADP survey estimated that private employment growth increased by only 41k in December. Similarly, the latest JOLTS survey revealed that job openings dropped to the lowest level since September 2024. Overall, the data continues to indicate that labour demand remains weak, but there has been no sharp increase in job layoffs which have remained stable. Based on recent comments from Fed officials, the US labour market would have to deteriorate further to bring forward plans for further rate cuts this year which was not supported by yesterday’s data releases. The Fed has clearly signalled it plans to leave rates on hold this month after three consecutive rate cuts to allow more time to assess the health of the US economy. There are currently only around 4bps of Fed cuts priced in for this month. Tomorrow’s NFP report would have to be much weaker than expected to prompt a fourth consecutive rate cut and trigger a sharp reversal of recent US dollar gains. Our updated FX forecasts released in yesterday’s Annual Outlook report revealed that the we expect the US dollar to hold up better at the start of this year before weakening further as the year progresses. Please see the report for more details (click here).        

USD PERFORMANCE VS SHORT-TERM YIELD SPREADS

Source: Bloomberg, Macrobond & MUFG GMR

AUD/JPY: Favourable conditions for carry trades encouraging weaker yen

The yen is continuing to consolidate at weaker levels at the start of this year while the JGB market has been more volatile. The 2-year JGB yield hit a fresh high of 1.20% at the start of this week but has  since dropped back to a low overnight at 1.12%. At the same time, the 30-year JGB yield which had been consolidating at higher levels over the last couple of months, has regained upward  momentum this week hitting a fresh high at 3.53% yesterday. Japan held another 30-year auction overnight which attracted a bid/cover ratio of 3.14. It was lower than the 12-month average bid/cover of 3.41 but was not considered weak enough to trigger further selling. In our Annual FX Outlook report (click here), we assess the fiscal risks in Japan which have deteriorated since Sanae Takaichi became Prime Minister. Our analysis revealed that sell-offs at the long end of the JGB curve have become more correlated with yen weakness. We see a rising risk that the Japanese government may be forced into some degree of policy reversal. With inflation at 3%, fiscal expansion under way and the BoJ real policy rate still negative, JGB instability risks are highest. MoF intervention coinciding with a more hawkish shift from the BoJ could help to reduce these risks. If the current policy landscape doesn’t change a USD/JPY break higher through 160.00 is a realistic prospect.

At the same time, the external backdrop is current encouraging the build-up of short yen-funded carry positions given improving global investor risk sentiment and low  financial market volatility. Global equities have risen to new record highs at the start of this year while JPMorgan’s Global FX volatility index has fallen to its lowest level since March 2024. With market participants’ now more comfortable with President Trump’s policy implementation after the disruptive start in 1H 2025, and the majority of G10 central banks likely to leave rates on hold in 2026, the backdrop currently appears favourable for low FX volatility to continue at the start of this year. It should provide support for higher yielding G10 currencies such as the Aussie which have benefitted recently as well from building optimism over stronger global growth and the strengthening renminbi. It helped to lift AUD/USD to fresh high of 0.6767 yesterday before correcting lower overnight.

The Aussie has been undermined overnight by comments from  RBA Deputy Governor Andrew Hauser that have put a dampener on expectations for the RBA to quickly pivot to rate hikes after ending their easing cycle in the second half of last year. He stated that Australians have probably seen the final rate cut of the easing cycle as he described inflation of above 3.0% as “too high”. However, he emphasized that the RBA is taking a one-to two-year view on inflation and won’t react to individual data releases. He did note though that if the Q4 CPI report due at the end of January was “spectacularly high or low, we’d have to ask ourselves what was driving that, and that might be an important part of our overall judgement”. Together with the softer CPI report for November, the comments have dampen market expectations for a hike as soon as in March or May.         

KEY RELEASES AND EVENTS

Source: Bloomberg & Investing.com