Three's Company
- The bias is for a stronger USD as markets wax and wane between three key themes: U.S. economic outperformance, military tension in the Middle East, and risk-on dynamics.
- ECB policymakers continue to set the stage for an easier policy stance.
- There are no policy-relevant economic data releases today. Please see our Drivers for the Week Ahead for an in-depth look at what markets are facing this week.
USD and Treasury yields are consolidating near multi-week highs triggered by Friday’s outstanding U.S. September jobs report. Non-farm payrolls surged 254k, overshooting consensus of 150k and the average monthly gain of 203k over the prior twelve months. Additionally, average hourly earnings unexpectedly picked-up and the unemployment rate fell one tick to 4.1% on an unchanged participation rate of 62.7%. Fed funds futures are now pricing about 50 bp of cuts by year-end vs. 75 bp last week.
Even Chicago Fed President Austan Goolsbee (2025 voter) had to tone down his dovish rhetoric following what he described as a “superb” jobs report. Goolsbee had emphasized on several occasion that rates have to come down a lot over the next 12 month. He did not repeat this message Friday and instead noted the Fed has time to figure out where rates will settle.
Three central themes are steering financial markets:
(i) U.S. economic outperformance. In September, the U.S. composite PMI hit 54.0. The Eurozone was at 49.6, the UK at 52.6, Japan at 52.0, and China at 50.4. This theme favors a firmer USD because there is greater room for an upward reassessment in U.S. interest rate expectations relative to other major economies.
(ii) Military tension in the Middle East. Israel is still weighing how to respond to last week’s ballistic missile attack by Iran. This theme supports a firmer USD and is a drag on risk assets. The dollar’s dominance as an international currency means it performs well during periods of risk aversion. CHF and JPY also benefit because of their countries’ large net foreign asset positions.
(iii) Risk-on dynamics. China has turned-on the policy tap, and the Fed is dovish while the U.S. economy is strong. This theme bodes well for risk assets and growth-sensitive currencies. Indeed, iron ore future prices on the Singapore exchange are breaking higher after bottoming-out late last month.
Financial markets will wax and wane between these three themes in the coming weeks, with the bias for a stronger USD. There are no policy-relevant U.S. economic data releases today. Bowman (voter), Kashkari (non-voter), Bostic (voter), and Musalem (2025 voter) speak this evening.
EUR/USD is trading heavy under 1.1000. ECB policymakers continue to set the stage for an easier policy stance. Governing Council member Francois Villeroy de Galhau said overnight the ECB will “quite probably” cut interest rates at next week’s meeting, which is virtually fully priced-in by markets. The French central bank chief added the ECB has to pay attention to the risk of undershooting its 2% inflation target “due to a weak growth and a restrictive monetary policy for too long.” The comments support market pricing for an additional 150 bp of ECB rate cuts over the next twelve months.
A handful of ECB officials are scheduled to speak today, notably Chief Economist Philip Lane (8:45am London). On the data front, the highlights are the Eurozone October Sentix investor confidence index (9:30am London) and August retail sales (10:00am London).
USD/JPY is range-bound near recent highs around 148.50. The Bank of Japan (BOJ) loose for longer policy stance remains a drag for JPY. Japan’s newly appointed finance minister Katsunobu Kato stuck to government’s well-honed currency script noting “we will carefully watch the impact of forex moves on the Japanese economy and people’s lives.”
