The US dollar is cruising into a third day of losses and Treasury yields are softening even as investors brace for what is expected to be another strong payrolls report. North American equity futures are rallying ahead of the open after Apple reported stronger-than-expected earnings and provided a more optimistic sales forecast, and risk-sensitive currencies like the Canadian dollar are advancing off very low levels.
Economist estimates going into this morning’s non-farm payrolls number are widely dispersed, ranging from a 150,000-position gain on the low end to 280,000 on the high end, with the median landing near the 240,000 mark. After yesterday’s lower-than-expected jobless claims number, an upside surprise would hardly come as a shock – the headline print has topped consensus forecasts in 23 of the last 27 months – but a downside miss might trigger a fairly profound market reaction, reawakening fears of “stagflation” in the US economy.
Yields have fallen sharply over the last three days, with traders firming bets on a rate cut by November after Jerome Powell adopted a less-than-hawkish stance in Wednesday’s post-decision press conference. In a series of wide-ranging responses to questions from reporters, the Fed chair repeatedly indicated that he considers current policy settings to be “restrictive,” despite overwhelming evidence of an easing in market-based financial conditions. This suggests that officials remain convinced that borrowing costs remain well above the ‘neutral rate’ – the rate that can keep “output growing around its potential rate in an environment of full employment and stable inflation” – as former vice chair Lael Brainard put it in 2018. Comparing estimates of the long-run neutral rate generated from a model developed by Fed economists Kathryn Holston, Thomas Laubach and John Williams with the current real policy rate suggests that an “easing bias” – a willingness to cut rates at the first sign of incipient economic softness – remains intact, leading us to suspect that the market pendulum may have swung too far against in recent months.
The British pound is currently inching higher amid a broader improvement in risk appetite, but we think next week’s Bank of England meeting could represent a downside risk. Officials have mostly not joined markets in applauding a recent improvement in economic data, suggesting that the inflation outlook provided alongside the decision could show at least two – maybe even three – rate cuts forecast in 2024 – down from the four projected in February, but more aggressive than current market expectations would seem to indicate. A shift in the voting balance is also possible as other policymakers join Swati Dhingra in arguing for a cut.
The Japanese yen is grinding higher after two episodes of suspected intervention in the space of three days this week. The exchange rate is flirting with the 153 mark after briefly breaking the 160 threshold on Sunday night, and traders are wary of further buying from the Bank of Japan. With the US set to release a potentially market-moving non-farm payrolls report and Japan on holiday through Monday, liquidity conditions will be thin, giving policymakers plenty of opportunities to maximise market impact.
Japan’s intervention efforts are raising implied volatility in currencies traditionally involved in “carry trades” – transactions in which speculators borrow in low-yielding yen and invest in higher-yielding currencies – but returns have thus far remained consistent with post-pandemic trends. Returns on yen-funded purchases of the Colombian peso, Mexican peso, Brazilian real, Australian dollar – and even the greenback – are all strongly positive on a one-year basis, with this week’s moves failing to reverse the trend. Gains should shrink in coming months as volatility rises and yields come down in emerging markets, but for now, a trade that has long been known as “picking up nickels in front of steamrollers” remains in rude health.
