Market Brief: Dollar Edges Lower Into Payrolls

The dollar is trading near a one-week low as the minutes count down to what could easily become the year’s most pivotal data release: the August non-farm payrolls report. With investors broadly convinced that the data will improve, but nonetheless set the stage for at least one jumbo-sized rate cut from the Federal Reserve this autumn, the greenback is slipping against its major rivals, especially the yen, while Treasury yields are edging lower, and stock futures are coming under pressure.

Consensus estimates suggest that the US added 165,000 new jobs in August, up from the 114,000 reported in July, but down from the 215,000 average in the twelve months prior. The unemployment rate is seen falling back to 4.2 percent after approaching 4.3 in the previous month.

The headline job creation number will likely trigger volatility, especially if it is significantly above or below the 150,000 mark. But the deeper market reaction will hinge on the degree to which the unemployment rate climbs - and on why it climbs. July’s weakness was substantially concentrated in a sharp increase in the number of Americans on “temporary layoff,” leading some to believe that the month’s downside surprise amounted to a weather-induced statistical aberration rather than evidence of a sharp deceleration. Investors will interpret a rise in joblessness, particularly if generated through a jump in permanent layoffs, as clearing the way for an swift and aggressive response from policymakers.

Data released yesterday largely failed to support the case for a deeply front-loaded easing cycle. The number of people filing new claims for unemployment insurance fell to 227,000 in the week ended August 31, dropping by 5,000 from a week prior. Continuing claims fell by 22,000 to 1.8 million in the prior week. And the S&P Global service sector purchasing manager index - which covers a far wider swath of the US economy than the manufacturing report earlier in the week - showed activity remaining firmly in expansionary territory, even as hiring intentions softened and more respondents discussed layoffs.

Market positioning suggests that the dollar could move sharply in the coming hours. Options prices and speculative bets in the futures markets are clearly biased toward further weakness in the greenback, meaning that an extension of prevailing trends could go a long way - or reverse in a violent manner as punters are forced to unwind their trades.

But - absent an extreme downside shock in this morning’s data - we expect Fed officials to sand the edges off the market reaction later today. New York Fed President John Williams - an intellectual heavyweight - and Governor Christopher Waller - often considered a bellwether for opinion on the Federal Open Market Committee - are scheduled to speak, and seem likely to downplay the likelihood of a sharp knee-jerk reaction to signs of softness in labour markets, even as they ratify dovish views on Fed policy in the longer term. Today’s opportunity to talk market participants off ledges is somewhat unique - Fed officials are rarely afforded a chance to respond to data in real time - but San Francisco’s Mary Daly and Chicago’s Austan Goolsbee delivered similar messages yesterday, suggesting that the consensus on the committee is still aligned with a gradualist approach to easing.

The Japanese yen is the clear outperformer on currency markets this morning, trading near a one-month high as demand for safe havens intersects with an ongoing hawkish tilt from the Bank of Japan in bolstering the currency’s long-run outlook. Wage and consumption data releases earlier in the week pointed to a steady improvement in economic momentum across the Japanese economy, and central bank officials have made no secret of their desire to keep normalising monetary policy, abandoning the easy-money policies that remained in place for most of the last two-and-a-half decades. Consensus forecasts are slowly edging up, with the dollar-yen exchange rate now seen hitting 137 by the end of 2025.

The euro is struggling to make headway ahead of next week’s policy meeting. The European Central Bank is widely expected to deliver its second rate cut in this easing cycle, but still-sticky services inflation and an ongoing increase in real wages are likely to limit room for rhetorical manoeuvre, meaning that officials will almost certainly remain circumspect on the likelihood of further cuts in the autumn months. The pound is marginally outperforming its Continental counterpart, with the Bank of England seen responding to a broader improvement in economic fundamentals with another “finely balanced” decision to stay on hold later in the month. The euro area is seen easing rates by 160 basis points over the next year, against 129 in the UK, and 223 in the US.

Overall implied currency volatility is ramping up, but still looks fairly muted relative to history. Conditions are shifting rapidly, but with financial conditions remaining accommodative, most major economies experiencing similar dynamics, and central banks moving in lockstep, the ingredients for huge moves in exchange rates aren’t yet in place. We expect this to change in coming months, particularly as rhetoric surrounding the US election heats up.

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