Fed Hike Expectations Retreat After Weak US Jobs Report

On Thursday, the question hanging over currency markets was how hawkish the Federal Reserve would dare to be. 
By Friday afternoon, that question had changed.

The US economy lost 23,000 jobs in July against expectations for a gain of around 80,000. June's figure was also revised down to just 20,000, while May was cut to 63,000.

The result was a significant downside surprise and has left the Dollar on the back foot heading into the weekend.

What today's NFP data changed

Coming into Friday's report, markets were pricing roughly a 57% chance that the Fed would raise rates at its meeting on 16th September. That expectation had been doing a lot of the work in supporting the Dollar.

Friday's report has taken some of the legs from under it.

Payrolls fell by 23,000, annual wage growth slowed to 3.2%, and previous employment figures were revised lower by a combined 103,000.

The unemployment rate actually fell from 4.2% to 4.1%, although this came alongside another decline in labour-force participation, making the improvement less encouraging than it first appears.

The market response was immediate. The probability of a September rate hike fell to roughly 44%, while the Dollar weakened as investors reassessed the path for US interest rates.
GBP, EUR and CAD made noticeable gains against the Dollar following the release.

Why a September hike could still happen

It would be a mistake, however, to treat one employment report as the end of the story.

The Fed will receive another jobs report and two further CPI readings before it meets in September, and inflation remains the reason the committee has become more hawkish in the first place.

US consumer prices are still 3.5% higher than a year ago, well above the Fed's 2% target. Energy remains an important part of that picture, while strong investment linked to AI and data-centre infrastructure is providing another source of demand across the US economy.

There is also clearly support within the Fed for tighter policy. Three policymakers voted for an immediate 25 basis point increase at the July meeting, when the Fed instead chose to leave rates unchanged at 3.50-3.75%.

Chair Kevin Warsh has so far avoided giving markets firm forward guidance, but the Fed's focus on bringing inflation back towards its 2% target remains clear.

Worth watching will be the Jackson Hole gathering of central bankers at the end of August, Warsh's first as Fed Chair, for any indication of how he is weighing weaker employment against persistent inflation.

EUR/USD

For EUR/USD, the interest-rate picture has become increasingly important.

For the first time in several years, both the Federal Reserve and European Central Bank are dealing with the possibility of higher rates.

The ECB raised rates by 25 basis points in June, taking its deposit rate to 2.25%, before leaving rates unchanged in July. Its next monetary policy decision comes on 10th September.

That provides the Euro with a degree of interest-rate support that simply was not there for much of the previous two years. If that divergence continues, EUR/USD could remain supported.

Brent crude has fallen back towards $82 a barrel as markets assess developments in the Middle East and the possibility of progress towards reopening the Strait of Hormuz.

A sustained fall in oil would ease some of the inflation pressure facing both central banks, but could weigh particularly heavily on the Dollar if it further reduces expectations for Fed tightening.

The risk works in the opposite direction as well. A renewed escalation in the Middle East and another sharp rise in oil prices would quickly revive inflation concerns and could put a September Fed hike firmly back on the table.

With five weeks still to go and several major data releases ahead, neither a September hike nor a hold can yet be ruled out.

What this means for businesses

The calendar:

If you have a Dollar requirement in the coming weeks or months and would like to discuss the market or your available options, please speak to the Lamera Capital dealing team.