USD rebound loses upward momentum ahead of NFP report

USD: US labour market & diversification concerns trigger correction lower

The US dollar has continued to trade at weaker levels overnight after correcting lower at the start of this week.  After hitting a high of 97.986 at the end of last week, the dollar index has fallen back below the 97.000-level. The US dollar sell-off yesterday was reinforced by comments from National Economic Council Director Kevin Hassett who stated that “I think we should expect slightly smaller job numbers that are consistent with high GDP growth right now”. He cautioned that “one shouldn’t panic if you see a sequence of numbers that are lower than you’re used to, because, again, population growth is going down and productivity growth is skyrocketing”.  As a result, he believes that the so-called breakeven rate is “quite a bit lower” than it was under former President Biden. The breakeven rate is the number of jobs required each month to keep the unemployment rate steady. The comments have understandably dampened expectations for job growth ahead of the delayed release tomorrow of the nonfarm payrolls report for January. The current Bloomberg consensus forecast is looking for private sector employment growth to pick-up to 70k in January compared to compared to an average of 43k in the second half of last year. Market concerns over persistently weak labour demand were also reinforced last week by the sharp drop in job openings which has cast some doubt on the Fed’s judgement at the latest FOMC meeting that downside risks to the labour market have eased. If  labour demand continues to remain weak it will keep alive expectations for the Fed to lower rates further this year. The US rate market has been moving to price in more Fed cuts, and is currently pricing in around 58bps of easing by the end of next year. However the timing of the next rate cut is not expected until the new Fed chair is likely to be in place at the June FOMC meeting. We outlined our thoughts in more detail on the potential impact of former Fed Governor Kevin Warsh taking over as Fed chair in our latest FX Weekly (click here).       

At the same time, the US dollar has undermined yesterday in party by renewed concerns over diversification flows out of the US. It was triggered by a Bloomberg report stating that Chinese regulators have advised financial institutions to rein in their holdings of US Treasuries, citing concerns over concentration risks and market volatility, according to people familiar with the matter. The report added that officials urged banks to  limit purchases of US government bonds and instructed those with high exposure to pare down their positions. The directive does not apply to China’s state holding of US Treasuries. The officials reportedly stated that the move was framed around diversifying market risk rather than anything to do with geopolitical manoeuvring or a fundamental loss of confidence in US creditworthiness. The report highlighted that China’s holdings of Us Treasuries has consistently declined over the past decade falling to USD683 billion in November although it may have shifted some of its holdings to custody accounts in Europe. Belgium for example has since its US Treasury holdings increase to USD481 billion. Unlike for the US dollar yesterday, there was no sell-off in US Treasury market indicating market participants are not overly concerned by the report.               

USD HAS BECOME MORE CLOSELY ALIGNED TO YIELD SPREADS AGAIN

Source: Bloomberg, Macrobond & MUFG GMR

GBP: PM Starmer set to hang on until local elections in May?

The pound has had a volatile start to this week driven by the flare up in UK political risks. EUR/GBP jumped to a high yesterday of 0.8742 but has since dropped back closer to the 0.8700-level. The pound sell-off was reinforced by the resignations of his Chief of Staff Morgan McSweeney and Head of Communications Tim Allen which was then quickly followed up by Anas Sarwar, the leader of the Scottish Labour party, calling for Prime Minister Starmer to resign. He insisted that the “distraction needs to end and the leadership in Downing Street has to change” before the upcoming Scottish parliamentary elections in May. However, the immediate threat to Keir Starmer’s position as prime minister has since eased after cabinet ministers displayed unified support including potential leadership challenger Health Secretary Wes Streeting. According to local media reports, ministers were told to voice their support for the PM by the end of the day or face the sack. PM Starmer then made a defiant address to Labour MPs later in the day vowing to battle on, he stated “every fight I’ve ever been in, I have won”. According to Labour sources there is strong opposition within the party to triggering a leadership contest before the local elections in May. A development that should help to reduce the risk of a sharper pound sell-off in the near-term.            

KEY RELEASES AND EVENTS

Source: Bloomberg & Investing.com