Further Than That

The FOMC stayed on hold
The outcome most thought would unfold
But ‘further’ than that
What they hinted at
Was on future hikes they were sold

Yesterday played out much as expected with first a strong ADP number (234K) having virtually no impact on the dollar, although it did seem to underpin the equity market in the morning. As I wrote then, given the previous strong print which was followed by a weaker than expected NFP number, pundits put less stock into a beat this month. Then the FOMC released their statement in the afternoon and the universal reading was of a slightly more hawkish stance going forward. The proximate cause of this view was the insertion of the word ‘further’ into the statement at two different points, highlighting a potentially more aggressive stance than previously expected. The key phrase was the following: “The Committee expects that economic conditions will evolve in a manner that will warrant further gradual increases in the federal funds rate.” So it is pretty clear that they are going to be continuing down this path for a while yet, and while they remain somewhat data dependent, they continue to express confidence that the inflation rate will gradually rise toward their target of 2.0%. The FX market response to this was to see the dollar recoup its early session losses and close essentially unchanged on the day. Equity markets, meanwhile, gave back their early gains, also closing essentially unchanged on the day.

But now as we look at markets this morning, we see a mixed session in FX for the first time in more than a week. What had been entirely a dollar story has now evolved into more specific currency discussions. For example, the euro is slightly higher this morning, up 0.25%, after PMI data showed continuing strength in the Eurozone economy. While the reading was unchanged at 59.6, that remains in strong growth territory. The pound has also benefitted this morning from data with Nationwide House prices rising a more than expected 3.2% on a Y/Y basis. While it seems it was more due to a lack of supply rather than an increase in demand, the pound has nonetheless benefitted by roughly 0.15%. However, the yen is finding itself under pressure this morning, down 0.4%, despite a better than expected PMI reading of 54.8. Perhaps it was the significant outflow of foreign equity investment that accompanied the Nikkei’s recent week-long streak of declines. Ironically, the weaker yen supported the Nikkei which itself rallied 1.7% overnight. The one other noteworthy aspect of G10 currencies is the Skandies, where both SEK and NOK have been performing well. Fresh comments from a Riksbank governor describing comfort with the recent rise in Swedish inflation to target levels has the market looking for the first rate hikes in years.

Pivoting to the EMG bloc, it is ZAR which is underperforming today, down 0.5% despite an ongoing wave of positive news. The market seems to be taking profits after a better than expected PMI release of 49.9, much closer to the growth line than expected. However, given the rand has been the best performing currency for the past three months on the back of the politics involving Cyril Ramaphosa’s election to party leader, I guess a little profit-taking cannot be surprising. The dollar has had a solid day against its APAC counterparts after equity markets throughout the region (except in Japan) all continued their recent slide. My sense is that if US equity markets are able to rally today, the fears engendered earlier this week about a correction are likely to fade and we will head back to the narrative of stronger stocks and a weaker dollar.

Data this morning brings Initial Claims (exp 238K); Unit Labor Costs (0.9%); Nonfarm Productivity (0.8%) and ISM Manufacturing (58.8). While the ISM number could be meaningful, with the payroll report on tomorrow’s slate, I would be surprised if traders responded too aggressively to anything but a wild miss, something like 54.0. In fact, I think today’s most likely outcome is one of limited activity as all eyes turn their focus to tomorrow morning. The only caveat is the equity market, which if it fails to hold after some mixed earnings data overnight, could result in the first inklings of a risk-off scenario. After all, Treasury yields continue to rise (currently 2.74%) and that cannot be good for stocks, but should be good for the dollar. At some point, investors will not be able to resist the significantly higher yield on offer from the US compared to its G10 counterparts. However, it’s not clear today will be the day of change. Tomorrow, however, has possibilities.

Good luck