US Dollar Offered Ahead of the Employment Report

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Marc Chandler
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Overview: Risk appetites have returned but may be tested by the US jobs report. News of progress with US auditors in China helped lift Hong Kong and Chinese equities. Most of the large bourses in the region also rose. Europe’s Stoxx 600 is up a little more than 1% near midday after shedding 1.3% over the past two sessions. US futures also are trading with an upside bias. Benchmark 10-year yields are mostly a little softer today. The 10-year US Treasury yield is at 4.13%, down slightly. The greenback is softer against all the major currencies and most of the emerging markets as well. The dollar-bloc leads the G10, while Thailand and Hungary lead the emerging market currencies. Softer rates and the US dollar are helping gold recover from the push below $1617 yesterday. It is probing $1645-$1650. December WTI is moving above $90 to reach its best level since October 10. US natgas has been alternating between gains and losses this week. It was off about 4.7% yesterday and is up a little more than 4% today, ostensibly on weaker stocks. Europe’s benchmark is 1.6% lower around 122.1 euros. It finished last week at 110 euros. Iron ore, which snapped a six-session slide on Tuesday, is up for the fourth consecutive session today. It has rallied 11% in this run. December copper is jumping 3.3% and is at its best levels of the week. After falling almost 7% over the past two sessions, December wheat has come back bid and is up nearly 1.2%.

Asia Pacific 

News that the US audit process of Chinese companies, required to prevent delisting has proceeded faster than expected helped lift Chinese stocks. An index of mainland companies that trade in Hong Kong rose nearly 6% today and led the region with an 8.9% gain this week. The Hang Seng rose 5.3% for an 8.6% advance this week, easily the best performer in the region. The CSI 300 gained nearly 3.3% today and 6.4% for the week. There had been some speculation earlier this week that the zero-Covid policy would be abandoned but this was denied.

The PBOC has been raising the dollar's reference rate for six consecutive sessions through today. The dollar is allowed to rise by a maximum of 2% above the fix, so this means that the dollar's cap has been moving higher. At the same time, officials are gradually narrowing the gap between the fix and market expectations. That gap reached 950 pips on October 20 amid the Party Congress and narrowed to slightly less than 600 pips today.

Japan's markets re-opened after yesterday's holiday and played a little catch-up, with the Nikkei losing nearly 1.7%. The final October service and composite PMI were better than the flash readings. The service PMI was revised to 53.2 from 53.0 of the preliminary estimate and 52.2 in September. The composite stands at 51.8, not 51.7, and 51.0 in September. Both are at their best levels since June. Separately, we note that three-month implied yen volatility has slipped to its lowest level in three weeks, a little below 12.3%. The dollar is little changed against the yen this week.

In its monetary policy statement, the Reserve Bank of Australia upgraded its inflation outlook and pared its growth forecasts. Its preferred inflation measure, the trimmed mean is expected to peak at 6.5% at the end of this year (up from 6%) before falling to 3.75% by the end of next year and reaching the top of its 2-3% target in 2024. It shaved this year's growth projection to 3% from 3.25% and sees growth at 1.5% in 2023 and 2024.

The dollar is confined to a JPY147.50-JPY148.50 trading range. We suspect that support is stronger than resistance. Still, the dollar has not traded above JPY149 since October 25, and that was just barely. With a brief but notable exception, since the second week in October, the dollar has been largely confined to a JPY145-JPY150 range. The Australian dollar fell from almost $0.6500 on Wednesday to near $0.6270 yesterday. It has fallen for the past six sessions but has steadied today. It is firm but within yesterday's range today. The $0.6375-$0.6400 offers the nearby cap. The Chinese yuan is trading about 0.5% higher and recouping the losses of the past two sessions. The PBOC set the dollar's reference rate at CNY7.2555 and this ostensibly allows the dollar to trade as high as CNY7.40. It has not traded above CNY7.3120.

Europe

Germany's services and composite PMI were revised but still show the economy struggling. The service PMI is at 46.5, up from the preliminary 44.9 and above September's 45.0. The final composite is at 45.1. The flash reading was 44.1 and it was at 45.7 in September. Separately, September factory orders were dismal, falling 4%, compared with expectations for a 0.5% decline after a revised 2% fall in August (initially a 2.4% fall). The French PMI was also revised up, but both the services and composite PMI was softer than September. Still, they both held above the 50 boom/bust level. The service PMI is at 51.7 (51.3 flash and 52.9 in September) and the composite is at 50.2 (from 50.0 flash and 51.2 previously). France also reported declines in September industrial output (-0.8%), and manufacturing (-0.4%). Italy's PMIs fell more than expected. The services PMI fell to 46.4 from 48.8, and the composite is at 45.8 from 47.6. Note that Prime Minister Meloni will present her budget today. Spain's service PMI rose to 49.7 from 48.5, but the composite slipped to 48.0 from 48.4. It reported that September industrial production fell 0.3% after rising by the same amount in August. The aggregate services PMI stands at 48.6, up from 48.2 of the initial estimate but still down slightly from September's 48.8. The composite is at 47.3, slightly better than the flash reading of 47.1, but down from 48.1. The composite has fallen since April's peak at 55.8.

The Bank of England delivered the 75 bp rate but warned that the terminal rate would likely be lower than the markets were discounting. BOE Governor Bailey said the markets saw a terminal rate of 5.25% next year. That may have been the case recently, but the swaps market has implied a policy rate peak slightly below 4.70% on the eve of the BOE meeting. The BOE warned that the economy may have contracted by 0.5% in Q3 as the UK enters a several quarter recession. The first estimate is due at the end of next week. The BOE sees the CPI peak at 10.9% later this year. This is down from a previous forecast of 13%. The BOE's forecasts do not take into account the budget that will presented November 17. Former Minneapolis Fed president, Kocherlakota had written an op-ed piece recently arguing that the BOE's regulatory lapse toward pension funds and its limited support for the Gilt market led to Truss's downfall. Bailey defended himself yesterday in an interview, claiming that it would have created a moral hazard. That seems to be a rather weak defense, no matter what one thinks about Truss's fiscal intentions. Can it be demonstrated that having the emergency program fully in place through the budget statement been a significantly greater moral hazard?  Bailey also sidestepped the question about the regulatory approach to the pension funds, and how does that relate to moral hazard?  

The euro initially rallied to $0.9975 on the initial dovish reading of the FOMC statement and reversed, falling to a low yesterday of about $0.9730. It has steadied today and has been confined to about a half-of-a-cent range below $0.9800. There are options there for 1.7 bln euros that expire Monday and another billion euros that expire Tuesday. The recent price action has weakened the technical tone of the euro and the five-day moving average is slipped back below the 20-day moving average for the first time in about three weeks. Yesterday's high was near $0.9840, and a close above there were begin repairing some of the technical damage. Sterling's high this week was recorded on Monday by $1.1615 and it fell to $1.1150 after the BOE meeting. Yesterday's 2% loss was the most since the turmoil in late September. It is making session highs in the European morning almost a cent higher. Initial resistance is likely in the $1.1300-10 area. Sterling has risen for the past three weeks for almost 4.8%. At $1.1240, it is off about 3.25% this week, making it easily the poorest performer in among the G10 currencies. The euro is second with about a 1.8% loss.

America

Today's US employment report is sandwiched between the FOMC meeting and next week's October CPI. The market looks for around a 200k increase in nonfarm payrolls. This is a smaller increase than the US has been reporting but would be a solid number. The monthly average in 2018 and 2019 was 150k. Contrary to some claims, the Fed is well aware of its two mandates of price stability and full employment. The unemployment rate was at 3.5% in September, matching the pre-pandemic low. Whatever full employment means, the Fed is closer to achieving that than reaching its inflation objective, hence the focus. That said, one dimension that is problematic because of the implication for potential growth is the participation rate. It stood at 62.3% in September. It first reached that in February after hitting a Covid-low of 60.2% in April 2020. However, before the pandemic struck the participation rate was 63.3%-63.4%. It never fully recovered from the Great Financial Crisis when the participation rate hovered around 66%. The Fed and many private sector economists had expected that higher wages would pull people back into the labor market, but we are more than homo economicus, and there appear to be some large social forces at work. 

In any event, as Fed Chair Powell has pointed out on numerous occasions, there is no one number that does for the labor market as the PCE deflator does for inflation. Powell continues to put stock in the job openings as a sign of tightness of the labor market. Weekly jobless claims can be noisy, and a four-week moving average smooths it out. In late 2019, the four-week moving average was 230-340k. It has held below 220k for the past seven weeks. Continuing claims have been gradually rising. At 1.485 mln in the week through October 21, it is the highest since March, but is still in its trough after bottoming in May near 1.306 mln. Before Covid, continuing claims were considerably higher. It was slightly below 1.9 mln at the end of 2019. Given the heightened sensitive to inflation, the average hourly earnings may be important. A 0.3% increase in October, matching the pace seen in August and September, would see the year-over-year rate ease to 4.7%, its slowest since August 2021. Recall average hourly earnings rose 2.9% year-over-year in December 2019, and this was seen as insufficient. At his press conference, Powell, explained, "I don't think wages are the principal story of why prices are going up. I don't think we see a wage-price spiral. But, once you see it, you're in trouble."

Canada also reports October employment data today. Canada's job creation has stalled. The number of full-time positions has fallen in three of past four months. It has created an average of 16k full-time positions a month this year. The average in the first half was around 38.5k. Counting part-time positions, Canada has averaged an increase of 19k a month. The median forecast in Bloomberg's survey looks for a 10k increase in jobs last month, half of the pace seen in September. Canada's labor force participation rate reached its pre-Covid level (65.5%) in September 2021 and has gradually pulled back to 64.7%-64.8% for the past three months. Still, despite the widening of policy rates, and the widening of the two-year US premium to near three-year highs, the exchange rate appears to be more a function of the general risk environment (S&P 500 as proxy) and the general direction of the US dollar. The 60-day rolling correlation of changes in the Dollar Index and the Canadian dollar is the highest it has been in six years. Separately, Canada announced a 2% tax on share buybacks (the US Inflation Reduction Act has a 1% tax) and it will launch a C$6.7 bln (~$5 bln) five-year tax credit program to clean energy projects. Lastly, we note that the government is now projecting a C$36.4 bln fiscal deficit. In April, it anticipated a C$52.6 bln shortfall.

The dollar-bloc is leading the move against the dollar among the major currencies ahead of the employment report. The Canadian dollar's 0.8% gain trails the Antipodeans, which are up slightly more than 1%. The greenback briefly traded above CAD1.38 yesterday and is near CAD1.3630 in Europe. The week's low was set Tuesday around CAD1.3530. We identified the CAD1.35 area as a key to the medium-term technical outlook. A convincing break would bolster the chances that the CAD1.40 level approached in late September was a significant higher. Some of the US dollar selling may be related to expiring options. At CAD1.37, there were options for $545 mln that expire today and another set for $500 mln at CAD1.3630. Yesterday's price action saw old USD support at MXN19.80 act as resistance. That area capped the greenback's bounce and it reversed to close below MXN19.65. It is fraying the MXN19.60 area in Europe. It reached a five-month low near MXN19.5065 on Wednesday. The low for the year was set on May 30 around MXN19.4150. The peso is the third best performing EM currency this week. Brazil is the best with a 3.5% gain coming into today, and the Thai baht is in second place with almost a 1.1% gain. The peso is slightly more than 1% higher this week ahead of today's local session.