Thanks to the second rate hike in June and worsening unemployment, weakening US data is keeping the Fed on its toes
Investors pay attention to slowing US figures
US Dollar weakness has been the underlying theme through June and July as markets continue to digest a weakening US economic data docket.
With the second rate hike materialising in June, investors are paying more weight to US figures, which have slowed through the second quarter. Key data points such as GDP and inflation haven’t grown at the pace of first quarter and this has allowed the Federal Reserve to adopt a wait and watch approach going forward which has kept any upside moves in the Greenback in check.
Friday’s trading following June’s nonfarm payrolls report would further lend weight to this case. The data came in much stronger than expected – headline payrolls increased to 222,000 new jobs in June (well above the expected 179,000), while May’s figure was revised upwards to 152,000.
Though the unemployment rate may have worsened to 4.4 per cent amidst a growing labour force participation rate (65.9 per cent actual versus the previous 65.8 per cent), which encouragingly showed that more job seekers were actively seeking work.
The dollar roared higher following the improving jobs data which confirms how sensitive traders remain to US figures. Perhaps the only dark spot on Friday’s report was the lack of growth in the average hourly earnings. Month-on-month earnings increased only 0.2 per cent, versus an expected 0.3 per cent, but above the previous month’s reading of 0.1 per cent. Average hourly earnings, which measures the change in prices that businesses pay their labour, is a particularly important reading which underpins inflationary pressure in the US – and this of course is a key mandate for the Fed and their future policy.
Despite mixed jobs and slightly weaker GDP – inflation will be the main focus for the Fed going forward. Price pressures have been tailing through second quarter and the recent wage figures allow the Fed to slow their hawkish rhetoric. All eyes will now turn to this Friday’s US consumer price index (CPI) reading. The CPI reading is the key inflation gauge and is expected to show that yea-on-year inflation growth is expected at 1.7 per cent, well below the Fed’s mandate of 2 per cent. With energy prices a big component of the CPI print, perhaps the core CPI reading (inflation less food and energy prices), expected at 1.7 per cent, may portray a more accurate picture. A reading below this expectation would continue to pile the pressure on dollar bulls and will see the Dollar Index re-test those June lows between 95 to 97 through third quarter.
The Fed finds themselves in a rather comfortable position. Delivering two rate hikes already in 2017, the Federal Open Market Committee now has until December’s meeting to see how the US data flow pans out. With markets not expecting any such Fed action until the end of 2017 at the earliest, we expect the Dollar Index to continue to consolidate in the channel between 95 and 97 in the months ahead.
The dollar weakness has seen crosses like EUR/USD and GBP/USD benefit and move into higher trading channels. Dubai Gold & Commodities Exchange (DGCX) Euro contract tested one year highs at 114.92 while the British pound contract tested 1.30 levels before finding strong tehnical resistance. While nothing would suggest an improving European data docket, the Euro and GBP have benefited from a deteriorating US Dollar. Expect to see 114.50 levels to hold in EUR/USD while short positions may be built in GBP/USD above 1.30 levels. Our initial targets of 1.25 in GBP/USD remain very much intact, albeit on a slightly longer time frame. Political developments and the UK prime minister Theresa May’s efforts to unify the government may have given short term boosts to pound bulls but the inevitable Brexit discussions will continue to cripple the currency in the medium term.
The other big loser on the month has been gold. DGCX’s Gold contract has fallen more than 4 per cent since mid-June. The precious metal has closed three consecutive weeks lower on the back of large position exits from exchange traded fund investors and hedge funds. Since the start of July, the precious metal has taken out several key technical indicators, most notably the 50 week and 100 week moving averages between 1,238-1,240. While the weakness is expected to continue in gold, we expect strong support to come in at 1202 levels which represents the 100 month moving average.
And finally, crude prices slipped through July following a move above 47 levels. DGCX’s West Texas Intermediary contract is more than 4.6 per cent lower following July’s opening and the contract now finds itself trading at a key support level of 43.90 levels which would need to hold before exposing 42 levels.
Gaurav Kashyap is a market strategist at EGM Futures