USD: Higher hurdle for sustained dollar gain

Friday’s negative NFP print is likely to influence FX sentiment in the early part of the week, at least through to the CPI release on Wednesday – the key macro release of the week. The -23k in contrast to the +80k expected and the previous two-month downward revision of -103k altered dramatically the current picture of labour demand. But the FX and rates reaction to such a downside miss was muted – USD/JPY fell just 0.4% and the 2-year yield dropped just 5bps. That makes a lot of sense with the two CPI reports and another NFP report before the next FOMC meeting on 16^th September meaning market participants were cautious about removing too much of the pricing for a hike at that meeting – the probability of a hike has still dropped from 55% to 40%.

Fed Chair Warsh may also have played a role in the muted reaction. Warsh has made clear he is sceptical of the quality of the data used to analyse the economy and the markets do increasingly view the payrolls reports with increased scepticism that results in more muted market reactions. And of course, such a large report also contains caveats that caution against over-interpretation. The unemployment rate, for example, fell from 4.2% to 4.1% which from a wage inflation perspective might keep wage growth supported. Kevin Hassett cited retiring baby boomers as a reason for the drop in unemployment and indeed in just two months, the labour force has shrunk by 1mn while employment fell by 600k. Still, the YoY rate for average hourly earnings fell from 3.5% to 3.2%, confirming the full retracement back to pre-covid levels and certainly underlining the lack of inflationary pressures coming from the labour market. There is also a case to be made that the weakness in the data now is merely reflecting a correction from an overshoot earlier this year. The 6-month average for private payrolls growth in July was 54k, up from 32k at the end of last year.

The muted yield drop must also be viewed in the context of the numerous hawkish communications from FOMC members. Most of these hawkish comments have been from Presidents rather than Governors but a larger cohort of hawks certainly makes it more difficult for the Board of Governors to ignore, especially with three dissents in July. Let’s see what the CPI data bring on Wednesday but another weaker than expected core CPI print (which would be the third month in a row) along with last week’s weaker jobs would certainly provide compelling ammunition for the doves on the FOMC although again we may not get a big market reaction this week either given the September data points lie ahead before the FOMC meeting.

US LABOUR MARKET INDICATES FULL REVERSAL BACK TO PRE-COVID WAGE GRWOTH LEVELS HIHGLIGHTING EASING INFLATION RISKS

Source: MUFG Research, MUFG Research, Financial Futures Association of Japan

JPY: Sharp retracement weaker

Remarkably, despite that negative NFP print on Friday the yen has failed to advance versus the US dollar. USD/JPY dropped sharply of course but bounced modestly on Friday from the lows but yen selling has resumed today and USD/JPY is trading exactly where it was when the NFP data was released on Friday. The yen remains notably stronger from the USD/JPY rate when intervention began (about 4-5 big figures lower) but there is good appetite to sell yen at these levels despite the US jobs report raising the prospects of that shift in fundamentals that is required for intervention to prove successful.

On the Japan side today we had the release of the Summary of Opinions from the policy meeting at the end of July. The details were certainly on the hawkish side and will add to the growing speculation that the BoJ will act sooner than was originally expected and faster than the now standard pace of every six months. One BoJ policy board members stated that it was “possible that the pace of interest rate hikes will be faster than the markets expect”. The BoJ needs to adopt a “nimble approach” and to “discuss the size of a rate hike, rather than adhering to a certain pace of rate hikes”. There was also a view expressed that the focus of the BoJ had now shifted from “lifting underlying CPI to the 2% target” to “avoiding further upward deviation in underlying CPI inflation”.

The JGB curve has shifted higher despite the drop in UST bond yields on Friday although the 2-year is close to unchanged. The OIS market does show that the potential for earlier action is much better priced now and hence the front-end rates reaction has been modest. The probability of an October rate hike is already priced at close to 96%.

After such a large FX drop in USD/JPY, market participants’ appetite for buying the yen could remain muted for now. Certain elements of the market, like retail FX margin traders, were short USD/JPY and could be playing a role in providing renewed yen selling flows. Those short USD/JPY positions have probably been liquidated but returning to a carry strategy (rather than directional) may be deemed as more attractive once again at these lower levels, encouraging renewed USD/JPY buying.

There was no surprise to see the IMM data on Friday evening show a large reduction in the yen short position reported amongst both Asset Managers/Institutional Investors and Leveraged Funds. The total combined net short position fell from 185k contracts to 103k, a near 45% reduction. This was a larger liquidation than in April/May when positions were reduced by 38%. Those sectors could also now be buying USD/JPY once again. With no resolution to the Middle East conflict and still no deal on reopening the Strait of Hormuz, Japanese energy companies may also be more active in buying US dollars at these levels. We would view Friday’s weak payrolls as reducing risks of a return to the pre-intervention highs in USD/JPY but equally at these levels not quite enough to encourage USD/JPY selling, certainly not ahead of this week’s key CPI data.

LARGE INTERVENTION-DRIVEN LIQUIDATION OF YEN SHORTS

Source: Bloomberg & MUFG Research