Dollar Soft Ahead of Jobs Report

September 02, 2022

Win Thin

U.S. yields continue to rise; August jobs data is the main event; August ISM manufacturing PMI came in firm
The stars are aligning for a 75 bp hike at the September 8 ECB meeting; eurozone countries reported some soft data
We downplay any notions of BOJ intervention as USD/JPY moves past 140; Korea reported August CPI

The dollar is soft ahead of the jobs report. After trading at a new cycle high yesterday near 110, DXY is trading lower near 109.323. The euro continues to struggle above parity and we believe it remains on track to test the September 2002 low near $0.9615. Sterling traded at a new low for this move yesterday near $1.15 but has recovered to around $1.1565 currently. With headwinds growing, sterling remains on track to test the March 2020 low near $1.1410. USD/JPY traded at a new high for this move near 140.45 today and we maintain our medium-term target of 147.65, the August 1998 high whilst downplaying BOJ FX intervention risks (see below). Indeed, we maintain our strong dollar call as markets are finally starting to price in the Fed’s hawkish message. While we don’t like to put too much weight on any one data point, today’s jobs data will be key for the dollar’s near-term direction.

AMERICAS

U.S. yields continue to rise. The 10-year yield traded near 3.30% yesterday, the highest since June 21, but has fallen back to 3.26% currently. Elsewhere, the 2-year yield traded near 3.55% yesterday, the highest since November 2007, but has since fallen back to 3.50%. The real 10-year yield is trading near 0.81%, just shy of the June 14 cycle high near 0.82%. The rise in rates reflect the ongoing repricing of the Fed’s likely tightening path. WIRP suggests nearly 75% odds of a 75 bp hike at the September 20-21 FOMC meeting, up from 50% at the start of last week, while the swaps market is pricing in a 4.0% terminal rate vs. 3.75% at the start of last week. It's not a coincidence that Fed officials keep bringing up Paul Volcker, as the implications are clear: U.S. rates are going higher for longer.

August jobs data is the main event. Consensus sees 298k jobs added vs. 528k in July, while the unemployment rate is expected to remain steady at 3.5% and average hourly earnings are expected to pick up a tick to 5.3% y/y. Markets don't know how much weight to put on the weak ADP number of 132k since new methodology was used. On the other hand, the ISM manufacturing employment component rose to 54.2 vs. 49.5 expected 49.9 in July and was the highest since March, suggesting a strong print today for manufacturing jobs. In addition, initial jobless claims fell to 245k while continuing claims fell to 1.412 mln for the BLS survey week containing the 12th of the month. While the labor market remains strong, there is no question that unemployment will eventually rise as the Fed continues tightening. However, keep in mind that the labor market is a lagging indicator.

August ISM manufacturing PMI came in firm. Headline was steady at 52.8 vs. 51.9 expected. Prices paid fell to 52.5 vs. 55.3 expected and 60.0 in July and was the lowest since June 2020. New orders rose to 51.3 after spending two months below 50. This was a strong report across the board and points to continue resilience in the manufacturing sector. July factory orders will be reported today and are expected at 0.2% m/m vs. 2.0% in July. ISM services PMI will be reported September 6 and consensus sees 55.2 vs. 56.7 in July, which was the highest reading since April. After a weak Q2 reading of -0.6% SAAR, GDP growth has picked up and the Atlanta Fed’s GDPNow model is currently tracking 2.6% SAAR for Q3. Next model update will be September 7.

EUROPE/MIDDLE EAST/AFRICA

The stars are aligning for a 75 bp hike at the September 8 ECB meeting. Eurozone PPI rose 37.9% y/y in July vs. 37.3% expected and a revised 36.0% (was 35.8%) in June. This suggests ongoing upward pressures on CPI in the coming months. WIRP suggests nearly 70% odds of a 75 bp hike next week, up from around 60% at the start of this week. The problem with large-scale ECB hikes (the same goes for the BOE) is that they are hiking into a recession that's pretty much already here. This is one of the primary reasons where heightened tightening expectations have done little to support the euro (and sterling).

Indeed, eurozone countries reported some soft data. Germany reported soft July trade data. Exports fell -2.1% m/m vs. -2.2% expected and a revised 4.2% (was 4.5%) in June, while imports fell -1.5% m/m vs. 0.4% expected and a revised 0.1% (was 0.2%) in June. Elsewhere, Spain unemployment jumped 40.4k in August vs. 3.2k in July and suggests that the economy is following the rest of the eurozone into recession. Final August eurozone PMI readings will be reported Monday, with Spain and Italy to report for the first time. We see risks that Spain’s composite PMI will fall below 50.

ASIA

We downplay any notions of Bank of Japan intervention as USD/JPY moves past 140. As we’ve noted in the past, it’s usually more about the pace of FX moves rather than any particular level that typically triggers intervention. Let’s look at this year’s rise in USD/JPY as three distinct phases: 1) from early March until the end of April, the pair gained nearly 14% before consolidating and falling 3.5% in May; 2) from early June until mid-July, the pair gained nearly 9.5% before consolidating and falling 6.5% in the second half of July; and 3) from early August until today, the pair has gained 7.5% and at some point will consolidate and gain some ground back. This has not been a one-way bet and so policymakers are unlikely to get involved trying to defend the yen, especially when the monetary policy divergence warrants yen weakness. As Governor Kuroda noted after the July 20-21 BOJ meeting, “If you were serious about stopping the weaker yen just with rate increases, you would need significant hikes and they would be very damaging to the economy.” We concur.

Korea reported August CPI. Headline came in at 5.7% y/y vs. 6.1% expected and 6.3% in July, while core fell a tick as expected to 4.4%. This was the first deceleration since January but inflation still remains well above the 2% target. No wonder the Bank of Korea hiked rates 25 bp to 2.5% last week. Governor Rhee the bank would continue with 25 bp hikes going forward, adding that the policy rate has already reached the middle of what it considers to be its neutral range. Rhee said that after reaching the upper part of that range, the bank will then consider if it needs to go higher. Next policy meeting is October 12 and another 25 bp hike to 2.75% is expected. top The swaps market is pricing in 100-125 bp of tightening over the next 12 months that would see the policy rate peak between 3.5-3.75%, up from 3.0% at the start of last week.

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