Market Briefing: Pain trade
USD rebound. Strong US labour market report sees pricing for Fed rate cuts later this year pared back.
Higher for longer. The US labour market is still very tight. We continue to think market pricing looking for Fed easing later this year is misplaced.
AUD under pressure. The AUD has fallen back as yield spreads adjust. RBA set to hike rates again tomorrow, but could it open the door to a pause?
A reality check for optimistic markets with the strong US labour market report pouring cold water on the idea the US Fed is near the end of its hiking cycle and could start to cut interest rates from Q3 2023. US equities ended the week weaker, with the S&P500 down 1% on Friday. By contrast, bond yields jumped up with the US 2yr rising 18bps to 4.29% and the 10yr lifting by 13bps to 3.52%. The ‘dovish’ reaction to last week’s US Fed meeting has been more than unwound. The sharp rise in US bond yields helped propel the USD higher. EUR is back under 1.08, ~2.2% below last weeks high, USD/JPY is above 132 for the first time since mid-January, and the AUD has tumbled back down towards 0.6890 (~3.7% below Thursday’s peak).
US non-farm payrolls rose by 517,000 in January, well above consensus expectations and the largest monthly increase since July. At 3.4% the US unemployment rate is at its lowest since the late-1960’s, and although average hourly earnings (a measure of wages) eased slightly, at 4.4%pa it remains too high. As the chart below shows, there are now ~1.9 job vacancies per unemployed person in the US. Members of the US Fed previously indicated that this ratio needs to be closer to 1 for wages to be running at a pace consistent with inflation tracking down around its 2%pa target.
The repricing in US interest rates, and assumption the US Fed could become more supportive later this year, has been one of the forces weighing on the USD over the past few months. The momentum in the US labour market is too strong for the US Fed to let up, in our view. The US Fed is a student of history and wants to avoid a repeat of the inflation and policy mistakes of the 1970s. We think the Fed may err on the side of doing too much than too little, and given the lags of policy looks set to keep interest rates higher for longer than markets think to be sure inflation completely flushes out of the system. This could be the message once again from Fed Chair Powell when he speaks this week (Wednesday morning). Markets adjusted after the US labour market data, but we believe there could be further to go, and that the USD may continue to regain lost ground over the period ahead.
Global event radar: US Fed Chair Powell speaks (8th Feb), US CPI (15th Feb), US retail sales (16th Feb), China CPI/PPI (16th Feb), Eurozone PMIs (21st Feb), FOMC meeting minutes (23rd Feb).
AUD fell back at the end of last week, with the strong US labour market data a shot across the bow for markets factoring in a swift turnaround in US interest rates later this year. The AUD’s pull-back over the past few sessions, largely due to the resurgent USD and shift in relative interest rate differentials, was in line with our thinking that up around recent highs (~0.7150) the AUD was discounting a lot of good news and that the USD had scope to recover given the markets complacency.
We think the AUD could ease down towards 0.6810 (200-day moving average) in the near-term as markets continue to adjust their thinking about how high US interest rates may rise this cycle and how long elevated rates need to stay in place. Fed Chair Powell speaks this week (Weds morning AEDT) and if discussed, the Fed’s higher for longer mantra could be repeated.
Tomorrow’s RBA meeting is also in focus and is the main AUD-centric event this week. We, and the market consensus, think the RBA will raise rates another 25bps, taking the cash rate to 3.35%. Inflation is still too high, and the economy has generally held up better than anticipated, so far at least, in the face of the RBA's rapid-fire hiking cycle. But beyond tomorrow’s move, we only foresee one more rate hike by the RBA. In our opinion, given how much work has already been done, how sensitive the indebted household sector is to higher rates, and the natural tightening set to unfold as the large pool of cheap fixed rate mortgages are refinanced, the pragmatic RBA could follow the lead of some other central banks and start to open the door to a conditional pause over the next few months. As seen last week, in reaction to their respective central banks contemplating the end of the rate hiking phase, currencies like the EUR and GBP weakened. Something similar could occur in the AUD, if the RBA follows suit.
AUD event radar: RBA policy meeting (7th Feb), US Fed Chair Powell speaks (8th Feb), US CPI data (15th Feb), AU jobs data (16th Feb), US retail sales (16th Feb), China CPI/PPI (16th Feb), RBA Gov. Lowe speaks (17th Feb), AU wages (22nd Feb), RBNZ meeting (22nd Feb), AU retail sales (28th Feb).
AUD levels to watch (support / resistance): 0.6810, 0.6857 / 0.7150, 0.7172
The rebound in USD/SGD has continued, with the pair now back above 1.3230 (~1.5% above last week’s low). The much stronger than anticipated US labour market report has seen market pricing for interest rate cuts by the US Fed later this year trimmed back. The jump in US bond yields has boosted the USD. The re-think by the market of its view that the inflation dragon has been slayed and that central banks, like the US Fed, could quickly morph back into growth supporting rate cutters in H2, could have further to run, in our view. This may see the USD (and USD/SGD) continue to recover in the near-term.
Labour markets remain too tight for central banks to be confident that inflation can seamlessly slow back down to target, and more importantly, stay there. US unemployment is now near a 50-year low, wage growth is still too strong, and monetary policy changes take time to fully effect the economy. It could take an extended period of tight monetary policy to generate the economic slowdown needed to weaken the US labour market and to get inflation truly back under control. That could be the message Fed Chair Powell repeats this week, if the macro/policy outlook is discussed.
SGD event radar: RBA meeting (7th Feb), US Fed Chair Powell speaks (8th Feb), US CPI (15th Feb), US retail sales (16th Feb), China CPI/PPI (16th Feb), Eurozone PMIs (21st Feb), FOMC meeting minutes (23rd Feb).
SGD levels to watch (support / resistance): 1.3050, 1.3110 / 1.3290, 1.3380
Currency Strategist - APAC
MONDAY (6th February)
AUD Retail Sales Volumes (Q4) (11:30am)
EUR German Factory Orders (Dec) (6pm)
EUR ECB’s Holzmann Speaks (7:15pm)
GBP BoE’s Mann Speaks (7:40pm)
EUR Eurozone Retail Sales (Dec) (9pm)
TUESDAY (7th February)
GBP BoE’s Pill Speaks (4am)
AUD Trade Balance (Dec) (11:30am)
AUD RBA Policy Meeting (Feb) (2:30pm)
EUR German Industrial Production (Dec) (6pm)
GBP BoE’s Ramsden Speaks (8pm)
GBP BoE’s Pill Speaks (9:15pm)
WEDNESDAY (8th February)
USD Fed Chair Powell Speaks (4am)
EUR ECB’s Schnabel Speaks (4am)
CAD BoC Governor Macklem Speaks (4:30am)
THURSDAY (9th February)
USD Fed’s Williams Speaks (1:15am)
EUR ECB’s Knot Speaks (2am)
USD Fed’s Kashkari Speaks (4:30am)
USD Fed’s Waller Speaks (5:45am)
GBP BoE Governor Bailey Speaks (8:45pm)
FRIDAY (10th February)
NZD Retail Card Spending (Jan) (8:45am)
AUD RBA Statement on Monetary Policy (11:30am)
CNH CPI/PPI Inflation (Jan) (12:30pm)
GBP GDP (Q4) (6pm)
SATURDAY (11th February)
CAD Employment Report (Jan) (12:30am)
GBP BoE’s Pill Speaks (1am)
EUR ECB’s De Cos Speaks (1:10am)
USD Consumer Sentiment (Feb) (2am)
EUR ECB’s Visco Speaks (8pm)
*Note, all times/dates provided are AEDT