Dollar soars before disaster payrolls report dents rally

We witnessed one of the most dramatic U-turns that we’ve seen in the US dollar for some time last week.

The first four days of the week were characterised by a broad dollar rally, as a solid GDP report, the signing of trade deals and a hawkish Fed acted to chip away at the greenback’s risk premium. Then came Friday’s nonfarm payrolls report, which not only completely changed the direction of the greenback, but has dramatically altered the market’s view towards the health of the US labour market and, subsequently, Federal Reserve rates.

President Trump’s 90-day tariff deadline has also come and gone, with a whole host of countries now facing significantly higher trade levies. The market reaction was relatively contained, however, which we see as largely due to the fact that most of the major deals have been done, and the expectation that the higher tariffs will only remain in place for a limited period. The US-China trade truce ends next week, but a delay here seems inevitable.

Next up for markets will be Thursday’s Bank of England rate announcement. Another 25bp cut seems highly likely, although we could see a three-way split vote, with remarks that hint at no more than quarterly rate reductions ahead.

GBP

Last week was an unusually quiet one in the UK that was almost entirely devoid of any major macroeconomic or policy news. Sterling instead largely traded at the mercy of broader dollar trends, which triggered a move in GBP/USD to its lowest level since mid-May, before the pair rebounded back towards the 1.33 handle following Friday’s disastrous payrolls report. Concerns surrounding Britain’s fragile fiscal outlook remain prominent, but with the pound left somewhat oversold by the recent move, there is arguably room for a mild pick-up.

Focus this week shifts to Thursday’ Bank of England announcement. Rising inflation and a near total capitulation of the jobs market places the MPC in a quandary. While we expect the majority to vote in favour of a cut, we would not be shocked to see a three-way split, whereby most vote for a 25bp rate reduction, a couple vote for a jumbo cut and one or two opt in favour of no change. Aside from the voting pattern, it will be interesting to see whether the BoE maintains its “gradual and careful” rate guidance. We suspect that it will, although any change here would almost certainly be greeted by a bout of GBP weakness.

EUR

The euro briefly sank below the 1.14 level on the dollar last week (before rebounding on Friday), as markets continued to cast a critical eye on the details of the US-EU trade deal. While the 15% tariffs are clearly nowhere near as high as the 30-50% threatened by Trump in recent months, markets and European countries were clearly hoping for a better deal that would both offer greater concessions and bring the baseline levy closer to the 10% that officials had pushed for during negotiations.

Market participants will now be attentive to the scale of the impact of the tariffs on the Euro Area economy, although we’ll have to wait until the August PMIs (23/08) for the first real read of this. So far, at least, economic activity is holding up relatively well, with last week’s Q2 GDP report (1.4%) and July inflation figures (2%) both surprising to the upside. This should take pressure off the ECB to lower rates again, and markets now see little more than a 50/50 shot of another cut from the Governing Council before the end of the year.

USD

We’ve seen an extraordinarily topsy-turvy few days for the dollar, which rallied sharply throughout the week before being whipsawed following the release of Friday’s payrolls report. The Federal Reserve had struck a hawkish note following its meeting on Wednesday, as chair Powell both talked up the strength of the jobs market and hinted that it was in no rush to ease policy again. In a rare turn of events, two FOMC officials (Bowman and Waller) did, however, vote in favour of an immediate cut - the first time that two governors had dissented at the same meeting in over thirty years.

This dovish dissent, as it turns out, was far from unfounded. On face value, the July payrolls print is not a big cause for alarm, although this was completely overshadowed by the almost unfathomably large downward revisions to the May and June figures totalling 258k. This has both almost entirely changed our view on the US jobs market, while completely shifted the narrative for the Fed, which now seems will have little choice but to cut in September.

 

Deep dives and expert insights:

• G10 currency market report- Get the latest analysis on major currencies.
• De-dollarisation playbook- Explore strategies in a shifting global currency landscape.
• BoE August Meeting Preview- MPC poised to slash rates again.
• US-EU Trade Deal: The Lesser of Two Evils- Learn more about the details behind the deal.