The USD Post-NFP: Where To?
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Last Friday’s US labor market report did not only provide a surprisingly low NFP reading of 38k for May. It also had significant downward revisions for prior months, taking the 3-month NFP average down to 120k from a 282k peak experienced last year. While the May report could still bean aberration, it was a weak enough report to put the Fed on the sidelines. The Yellen Fed is unlikely to take any risks and a rate hike therefore needs to be prompted by US data strength.
When the USD came off its February high, it fell 6.5% before bottoming out in early May. However, the spring USD downward correction received support from two sides. First, US rate-hike expectations eased with the help of disappointing US data releases turning the Fed dovish.Second,hopes for a China economic rebound were boosted by the sharp rise of China-related leading indicators (MS-CHEX) and social funding data showing a record expansion of credit. Now China has started reporting weaker data and commodity prices driven by China demand have declined, diverging from other commodities such as oil. Following this rationale, the current USD downward correction should be smaller than the spring USD decline.
For the FX markets, the reason US labor data moderated over recent weeks will make a significant difference. Is it because the labor market is approaching NAIRU and the decline in new-job creation will come along with rising wages?The Beige Book reporting tighter labor market conditions in 14 districts and average hourly earnings holding steady at 2.5% may be evidence of this. In this case, the Fed would keep its tightening bias intact, pushing the USD higher,and we would be wrong to make the above adjustments to our portfolio. But what if the US economy really is in worse shape than it appears? We would certainly then see the Fed maintaining its dovish tone and pushing out rate hikes even further.
...All in, we stay firmly convinced that the USD's secular bull market is not yet complete. Should US wages turn higher, the USD would likely move higher later this summer. Should the US been tering a cyclical slowdown, the USD would have more short-term downside potential of around 5% from here, before EM overcapacity worries put the USD back into its bull trend.
For now CHF and JPY offer better value than the USD.
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