Dollar Consolidates Ahead of Jobs Report

October 08, 2021
  • The Senate passed a short-term debt ceiling increase until December 3, as expected; higher US rates are helping the dollar; September jobs report will be the highlight; we believe that the bar to tapering has gotten pretty low; Canada also reports September jobs data
  • BOE warned of a potential correction in asset markets due to risk-taking at “elevated” levels; those risks will only rise if the BOE embarks on a misguided tightening cycle; ECB account of its September 9 meeting was very telling; Germany reported August trade data
  • Japan reported weak August real cash earnings and household spending; August current account data is worth discussing; RBA said in its semi-annual Financial Stability Review that it is important to maintain strict lending standards to prevent excessive borrowing in the housing sector; India kept rates on hold as expected but announced an abrupt end to the its bond purchase program

The dollar is consolidating its recent gains ahead of the jobs report as risk-on sentiment builds from a likely debt ceiling deal. DXY is down marginally for the second straight day near 94.15 after two straight up days. The euro remains heavy near $1.1565 after trading this week at the lowest level since July 2020 near $1.1530. Sterling is holding up better but has run into stiff resistance all week near $1.3650. Lastly, USD/JPY is benefiting from the risk on mood and is trading just below 112 and is on track to eventually break above last week’s high near 112.10.

AMERICAS

The Senate passed a short-term debt ceiling increase until December 3, as expected. It now goes to the House for a vote next Tuesday, where it is expected to pass. This positive news has boosted risk appetite by removing imminent default risk here in the U.S. Senate Majority Leader McConnell is coming under criticism from some in his party for caving to the Democrats, but really, this was the only sensible solution. The Democrats will now work to fold in a longer-term debt ceiling increase or suspension into its “human infrastructure” bill and pass both via the budget reconciliation process with no Republican support. Now, the biggest hurdle for the Democrats is to agree on a top-line number that can satisfy both the moderates and progressives. We tip that number to be somewhere just south of $2.5 trln.

Higher US rates are helping the dollar. The 2-year yield is trading at 0.32%, the highest since March 2020, while the 10-year yield is trading 1.60%, the highest since June 4. Of note, the 2-year U.S.-German differential is at 101 bp, the highest since March 2020 and a key factor behind recent euro weakness. Please see our recent piece “Tapering and the Dollar” for more insight into why we remain bullish on the dollar.

September jobs report will be the highlight. Markets are looking for a solid number as most of the clues so far have been good. ADP reported private sector jobs rose 568k vs. 430k expected and a revised 340k (was 374k) in August. As one might expect, Bloomberg consensus for NFP has crept higher to 500k from 488k pre-ADP. Other solid clues were provided by the ISM PMI readings, as the employment components came in at 53.0 vs. 53.7 in August for services and at 50.2 vs. 49.0 in August for manufacturing. Jobless claims yesterday showed continued improvement in the labor market, with initial claims coming in at 326k vs. a revised 364k (was 362k) the previous week and continuing claims coming in at 2.714 mln vs. a revised 2.811 mln (was 2.802 mln) the previous week.

We believe that the bar to tapering has gotten pretty low. Indeed, we feel that any reading above last month's 235k will be used as a trigger for a tapering announcement at the November 2-3 FOMC meeting. A strong jobs report today would likely keep upward pressure on yields and therefore the dollar, to state the obvious. August wholesale inventories and wholesale trade sales will also be reported today.

Canada also reports September jobs data. Consensus sees a 60k rise in employment vs. 90.2k in August, while the unemployment rate is seen falling two ticks to 6.9%. Yesterday, September Ivey PMI came in at a whopping 70.4 vs.66.0 in August. Despite the improving outlook, the Bank of Canada remains on hold near-term after it last tapered in July. Many expect one last round of tapering in Q4 but the timing will depend on how the economy rebounds in H2. Next policy meeting is October 27 and no change is expected then.

Peru’s central bank hiked rates by 50 bps to 1.50%, as expected. This is the third consecutive hike and consistent with the rising price pressures. CPI at 5.2% y/y, well above the 1-3% target range. However, the bank projects it will return to target over the next 12 months. Of course, the background of political uncertainty after the elections has led to increased risk premia and a weaker sol over the last few months. Yesterday’s move brings Peru’s rates in line with those in Chile, but there is still a long way to go until they offer a meaningful carry advantage.

EUROPE/MIDDLE EAST/AFRICA

The Bank of England warned of a potential correction in asset markets due to risk-taking at “elevated” levels. In its quarterly Financial Policy Summary, the bank’s Financial Policy Committee noted that “Asset valuations could correct sharply if, for example, market participants re‐evaluate the prospects for growth, inflation or interest rates.” The FPC also warned that risks in the leveraged loan market continued to build, with “signs of continued loosening in underwriting standards and increased risk-taking in some investment banking businesses.” However, it stressed that U.K. lenders were resilient to direct losses. Lastly, the FPC said that U.K. corporate debt vulnerabilities have increased “moderately” over the course of the pandemic but added that loan repayments are still manageable for most British businesses. We consider this report to be a blinking yellow light. That is, the BOE sees risks building that bear watching.

Those risks will only rise if the BOE embarks on a misguided tightening cycle. Mortgages and other floating rate debt will become more expensive to service. Next policy decision is November 4 and WIRP suggests nearly 25% odds of a hike then. The short sterling strip is still fully pricing in lift-off in Q1 22 followed by two more hikes over the course of the year. In fact, the market is starting to price in solid odds (over 50%) of a fourth hike in 2022. All of this pricing seems overly aggressive and such a tightening cycle would surely test the BOE’s risk scenario that was laid out in its Financial Policy Summary. Stay tuned.

The ECB account of its September 9 meeting was very telling. At that meeting, the bank announced that the pace of PEPP buying in Q4 would run at “a moderately lower pace” than in past quarters. The account showed that some were calling for “a more substantial reduction in the pace of purchases" because of greater inflation concerns. Yet in the end, the ECB went with a more balanced viewpoint. Those hawks have only gotten louder in the month since that meeting and we expect them to be more vocal at the October 28 meeting too. On the other hand, the doves can point to weaker real sector data as a reason not to remove accommodation too soon. While the fate of PEPP will surely be discussed this month, Lagarde has tipped the December 16 meeting for a final decision on QE. Panetta speaks today.

Germany reported August trade data. Exports were expected to rise 0.5% m/m but instead fell -1.2% vs. a 0.6% gain in July, while imports were expected to rise 1.8% m/m but instead jumped 3.5% vs. -3.6% in July. This led to a trade surplus of EUR10.7 bln vs. EUR15.0 bln expected and a current account surplus of EUR11.8 bln vs. EUR17.6 bln expected. Weakness in exports is of course worrisome, while the jump in imports is likely more tied to rising commodity prices than strong consumption.

ASIA

Japan reported weak August real cash earnings and household spending. Earnings were expected to rise 0.5% y/y but instead slowed to 0.2% vs. a revised 0.3% (was 0.7%) in July. Spending was expected to fall -1.2% y/y but instead plunged -3.0% vs. a 0.7% gain in July. Q3 is turning out to be a bit worse than anticipated but most (including us) are looking for a solid rebound in Q4 as the state of emergency ended and another fiscal package is in the pipeline.

August current account data is worth discussing. An adjusted surplus of JPY1.04 trln was posted vs. JPY1.15 trln expected and JPY1.41 trln in July. However, the investment flows will be of more interest. Data showed that Japan investors were net sellers of US bonds for the second straight month to the tune of -JPY551 bln vs. -JPY764 bln in July. Japan investors were also net sellers (-JPY139 bln) of Australian bonds for the fourth straight month and six of the past seven months. Japan investors were net sellers of Canadian (-JPY14 bln), and Italian (-JPY54 bln) bonds. Both have seen net selling for three of the past four months.

The Reserve Bank of Australia said in its semi-annual Financial Stability Review that it is important to maintain strict lending standards to prevent excessive borrowing in the housing sector. It noted that “In Australia, and some other countries, there have been large increases in housing prices and an acceleration in borrowing. Vulnerabilities can increase if housing market strength turns to exuberance.” The bank acknowledged the decision this week from the Australian Prudential Regulation Authority to tighten lending standards for mortgages. The RBA has long insisted that it would rely on macro-prudential measures to cool the housing market rather than the rather blunt tool of rate hikes. At this week’s meeting, the RBA affirmed its commitment to keep rates steady until at least 2024 and we think this regulatory focus is meant to underscore that.

The Reserve Bank of India kept rates on hold as expected but announced an abrupt end to the its bond purchase program. The repo rate remains at 4.00% and the reverse repo at 3.35%. The hawkish surprise came with the decision to halt the Government Securities Acquisition Programme (GSAP) and the announcement of long-term reverse repo auctions to drain liquidity. The move is very much in line with our thesis that EM CBs will continue to surprise on the hawkish side (please see our EM Central Bank Update – Hawkish Wave). The rupee appreciated sharply after the decision but has since given up the gains and is modestly weaker on the day, in line with the trend across most EM Asian currencies. The local 10-year yield was up 3 bps to 6.3%.

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