Last updated: February 5, 2015 12:59 pm
Dollar bulls face jobs report test
Michael Mackenzie
One constant of the new year has been a strengthening US dollar, until now.
The hefty appreciation of the dollar since last summer has been built on two major planks, the first being expectations of a stronger US economy propelling the Federal Reserve towards a tightening of policy in the coming months, while the second has been slowing global growth prompting easing by other central banks — notably in Japan and the eurozone — that results in sharply weaker currencies.
Since November, a host of central banks have eased policy and sought stimulus via a depreciating currency, with Australia being the latest example this week. That has certainly boosted the dollar, but of late the bond market has questioned whether the US central bank will start tightening policy by the middle of the year.
Last week’s Federal Open Market Committee meeting left that question open, with the onus on key economic data such as the monthly jobs report. Signs of oil prices stabilising and conjecture over the timing of Fed tightening have sparked some trimming of bullish dollar bets this week.
Renewed dollar strength, at least in the near term, requires a solid jobs report for January and one that is accompanied by evidence of rising wages.
“Payrolls are one of the most important data points for the month,” says Jens Nordvig, global head of foreign exchange strategy at Nomura Securities. “The Fed clearly tried to sound optimistic on the economy and keep a June rate rise on the table. The market doesn’t believe it.”
While economists expect the addition of 230,000 new jobs for January, down from the past four-month average of 284,000, the pace of wage gains during January looms as the key factor for currency traders and investors.
The December jobs report was marked by a surprise drop of 0.2 per cent in earnings that resulted in an annualised rise of just 1.7 per cent for workers. During prior business cycles, wages have expanded at a yearly rate of around 4 per cent, and the relative absence of better pay for workers has helped cap interest rates.
“A rise in earnings would mean the rate hike story is back on for this year,” says Mr Chandler.
Another weak month of earnings is seen pushing the Fed towards delaying rate rises until later this year, more in line with the bond market’s current expectations.
Anthony Karydakis, chief economic strategist at Miller Tabak & Co, says little or no rebound in wages during January “would leave a pocket of concern to the Fed, as the softness in wage growth has been a key missing part in the context of the ‘solid’ improvement in labour markets that the FOMC mentioned in its statement last week”.
A delay in Fed rate rises towards the end of the year may well pressure the dollar as traders with a short-term horizon trim bullish bets. Net bets on the US dollar rising remain close to all-time highs, according to US futures positioning data, and such crowded trades are vulnerable to sudden shifts in sentiment.
Recent sharp changes in currencies, such as a 10 per cent slide in the Canadian dollar over a six-week period, can swing back abruptly and catch out traders riding the positive momentum of the US dollar.
“People complain when there is little volatility,” says Mr Nordvig, and there is currently a lot of potential for surprises in the currency market he adds.
But the difference in the growth performance of the US and other key economies favours owning the dollar over the long haul, many argue.
Alan Ruskin, strategist at Deutsche Bank, says the recent appreciation of the dollar against the backdrop of lower US interest rates bodes well for the currency’s prospects. “The theme of global disinflation has encouraged many central banks both to ease policy and become more tolerant of foreign exchange weakness to help reflation,” he says.
In turn, Mr Ruskin says modest expectations for tighter policy from the Fed are a boon for the dollar as the outlook for the US contrasts sharply with the rest of the world.
Also propelling the dollar higher has been the attractiveness of higher US bond yields relative to the eurozone and Japan.
Mr Nordvig expects lift-off for US interest rate policy in September and such a prospect means the dollar will remain in favour.
The dollar’s long weakening run began in 2002 and ended during 2011, but only started breaking out last year.
“Once the trend changes, a currency gains its own momentum. We still see a longer term dollar uptrend for another year or more,” says Mr Nordvig.
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