The Federal Reserve recently detailed three major concerns in the June FOMC meeting that may affect their psyche on future monetary policy initiatives.
- The UK referendum and the impact it could have on financial markets
- Falling inflation expectations
- A further weakening trend in the labour market
Well, the UK referendum delivered perhaps the worst possible outcome for the US, as the probability of the Bank of England easing monetary policy in next Thursday’s policy meeting has increased markedly. The European Central Bank have detailed that they could look to adjust the requirements around its asset purchases program (Quantitative Easing or QE), therefore increasing the rate at which they can buy assets (a EUR negative). The prospect of the Bank of Japan and Reserve Bank of Australia (RBA) easing in upcoming meetings have also increased, although in the case of the RBA, the Q2 CPI print (released 27 July) will be the key decider.
For more on RBA policy, here is my take on yesterday’s RBA meeting.
US dollar basket
With other central banks stepping up their easing rhetoric, there is always going to be a winner: the USD. Technically, the USD has completed a bull flag pattern, which is in effect a continuation pattern and best portrayed on the four-hour chart. Long positions are preferred given the technical set-up, however I would keep positon sizing to a minimal given Friday’s payrolls data and the event risk this holds. I would look to add to long positions on a closing break of the recent high of 9,688, given this would confirm the idea is working. I would cut back on the trade on a move below 9490.
The USD basket is a weighted basket of currencies relative to the USD. The euro makes up the large bulk of the weighting.
The Federal Reserve (Fed) have its own measure of how inflation should average over the coming five years. They incorporate a range of instruments to get this pricing, but worryingly, the market is expecting US inflation to average 1.33% over the coming five years. This is not just well below the 2% target, but actually a record low. It highlights the Fed’s concern about how market participant see future inflation trends. It can’t in any way be seen as a positive that central banks have thrown the kitchen sink at trying to create inflation and the market’s inflation expectations are at record lows!
The US labour market
This then brings us to the US labour market and, as the Bloomberg chart shows below, the trend in the pace of monthly job creation is falling. This culminated in the May jobs report printing an awful 38,000 jobs, although this was impacted by a strike by Verizon workers. Taking the trend into consideration, the three-, six-, and year-to-date monthly averages are 115,000, 150,000 and 170,000 jobs respectively. So this highlights a worrying trend and makes this Friday’s payrolls print so important for confidence in the US economy.
The non-farm payrolls matrix
The economist’s consensus currently sits at 180,000 jobs created in June, with the economist range being 239,000 to 100,000, although this may change somewhat depending on tomorrow’s ADP private payrolls release (due at 22:30 AEST). The unemployment rate is expected to tick up to 4.9% (from 4.8%), while the hourly earnings are expected to highlight an annualised pace of 2.7%. On a positive note, 2.7% would be the fastest pace of wage growth since 2009. Given these expectations, I would use this matrix as a guide for markets to focus on:
Less than 150,000 jobs – Arguably this outcome would throw up the greatest volatility in markets and the question would then become whether the Fed cut rates in future meetings, or whether we are more likely to see another round of asset purchases (or QE4).
Traders should look to buy the JPY for its safe-haven qualities and specifically look to sell USD/JPY for a move into and potentially below ¥100. The S&P 500 (or US 500 on Puredeal) should head into 2050 on growing concerns of a future US recession, which investment banks such as Deutsche see as a 60% probability at present. Gold would likely head towards $1400, with silverfaring even better, and given the uptrend in both commodities, this would be the preferred trade.
The AUD/USD would likely rally back above $0.7500, with US interest rate markets likely to price in the chance of easing from the Fed.
160,000 to 180,000 jobs – On this outcome, the market will look for further clues on the economy, so will likely focus more intently on the unemployment rate and hourly earnings data. This print doesn’t really change the economic backdrop, but it does suggest last month’s terrible jobs release was a one-off, so there may be some relief expressed in markets. This could be a modest positive for the S&P 500, while could see AUD/USD trade modestly lower.
190,000 jobs and above – This scenario should provide some assurance to traders that the economy in the US is not as bad as perhaps feared and the probability of a rate hike this year would increase. Central banks around the world would naturally welcome this outcome. With this in mind, I would expect the USD basket to rally strongly and feed into the technical set-up portrayed above. Expect gold to come under strong selling pressure given hedge funds and other speculative participants have never held a larger net long position. GBP/USD would also be an interesting trade, as a strong jobs print would likely see the pair continue on its strong descent into $1.2500, despite being hugely oversold on a technical basis.