Fed is ready to raise interest rate in two weeks, long USD/JPY?
Below-estimated U.S. payrolls won’t change Fed’s rate decision this month
Total U.S. nonfarm payroll employment increased by 138,000 in May, well below the earlier economists’ forecast, and the unemployment rate was little changed at 4.3%, the U.S. Bureau of Labour Statistics reported last Friday. Job gains in March and April were revised down by 66,000 collectively. Job gains occurred in health care and mining last month.
The figures do not change the picture of U.S. economy growing steadily and closing in on full employment. It is unlikely to deter Fed’s rate hike in 10 days. It may casts doubt over the policy outlook in the coming year given persistently sluggish inflation numbers, but not for now.
Here are 5 reasons why Fed will continue to hike its policy rate by 25bps in ten days:
- Fed is not a day trader, they are policymakers
Dollar sold off upon the release of disappointing U.S. NFP, it looked like markets were paring back the bets on a rate hike. Facing the reality, a large number of traders in this trillion-dollar FX market don’t even have the basic knowledge on macroeconomics. If they think the Fed is going to react to a single economic release, this would be too naïve. What Fed focuses on is the trend. Nonfarm payrolls have been growing consistently in a range of 100k-300k in the past few years, with lower unemployment rate.
- Commodity prices are likely to continue to offer a life to U.S. inflation
The commodity markets have been especially volatile with items like gold and metals. While a number of different factors contribute to the prices of commodity, inflation is one aspect that has a direct impact on the prices of commodity. After China recent easy policy is over, investors start to worry about the upcoming inflation trend. Many of them seem to forget one key factor that could drive the inflation higher – weaker dollar. Most of the commodity prices are denominated in dollar; in other words, a softer dollar will influence the commodity prices higher.
Trump's economic proposals, such as slashing taxes, cutting regulation and pumping up infrastructure spending, lifted the US dollar after the election because many thought they could give the American economy a shot in the arm. But Trump's agenda has been delayed by political setbacks. There are no signs of Trump’s mega-stimulus plans going to be realised anytime soon, we don’t expect a sharp dollar rally in near term.
- Fear gauge – VIX index near historical low
In spite of a mixed response to the widely watched US jobs data on Friday, and political events set for this week, such as the UK election and testimony by former Federal Bureau of Investigation director James Comey before the Senate Intelligence Committee. Expectations of market volatility plumbed a historical low on Friday, with the CBOE’s VIX index closing at its lowest level since 1993 and US stocks hit fresh highs.
Persistently low volatility has nonetheless raised some concerns about complacency in the financial markets, and they could induce the Fed to raise interest rates to prevent assets bubble from growing bigger and bigger.
- Fed wouldn’t ignore ADP nonfarm payrolls
US private sector tacked on significantly more jobs than expected last month, underscoring the continued tightening in the labour market, according to ADP nonfarm payrolls last week. Private employers added 253,000 jobs in May, topping Wall Street’s forecast of 180,000.
Private sectors’ active hiring suggest U.S. labour market remains in healthy trend. The slowing down in officials’ NFP could be due to governments hiring slowing down amid uncertainty arising in Trump administration.
- China has pre-empted through its currency market
China intervened the CNH rates and FX market last week, many market participants think PBOC’s action is to give yuan more buffering to fall in case Fed raises interest rate in two weeks. Under this circumstance, PBOC does expect Fed to hike this month.
ECB meeting and UK election will rule FX sentiment this week
UK political developments and ECB meeting are this week’s main currency drivers. GBP will wax and wane in line with every opinion poll released ahead of Thursday’s UK general elections. Sunday’s YouGov poll suggests UK Prime Minister Theresa May’s Conservative party will win a 14 seats parliamentary majority. Our base case scenario is for the governing Conservative party to obtain a parliamentary majority of 9 seats, up from a current majority of 4. Historically, these polls are highly accurate. GBP/USD is at risk of a lift towards 1.3000 once the result is confirmed.
In Eurozone, ECB is widely expected to leave interest rates on hold on Thursday but we anticipate the ECB to remove its easing bias, which will underpin a firmer EUR. In our view the ECB will take out the reference to introducing further stimulus measures “if necessary” and note that risks to Eurozone growth outlook are more balanced rather than “tilted to the downside”. This is an implicit acknowledgement that deflationary risks no longer threaten Eurozone economy. ECB will not give details about eventual tapering of its asset purchases QE on Thursday. We expect ECB to detail its QE tapering policy at the September meeting instead. We maintain a buy on dip strategy for EUR/USD.
EUR/USD – Slightly bullish. We expect this pair to move towards 1.13 in coming days as ECB may withdraw some of its dovish tone.
USD/JPY – Slightly bullish. We expect the pair may move towards 110.80.
WTI/USD (WTI Crude oil) – Slightly bearish. We expect it to drop towards 47.60 within this week.
Top News This Week (GMT+8 time zone)
Eurozone: ECB Meeting. Thursday, 8th June, 7.45pm.
We expect ECB to leave the key lending rate unchanged (previous figure was 0%).
UK: Parliamentary Elections. Thursday, 8th June
Fullerton Markets Research Team
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