Labor markets gains support USD bulls
The market gained increasing comfort over the past month positioning for greater recognition by the FOMC of recent labor market strength despite their heretofore cautious tone. July’s payroll number was the first time payrolls have risen by 200K for six straight months since 1997, and also showed workers re-entering the labor force as well. Importantly, the median duration of unemployment has fallen sharply, suggesting reduced slack (Chart 6). The Q2 GDP report also suggested building momentum.
Together with a steady acceleration in inflation in recent months, we continue to see the risks skewed towards earlier-than-expected timing of the first rate increase as labor market gains amidst a broader pickup in growth pressures inflation higher. While wage growth remains anemic, giving the Yellen-led Fed cover for now, the increasing responsiveness of the short-end of the U.S. Treasury curve to improving data and evolving Fed expectations will feed through to the USD as the Treasury curve bear flattens.
Additionally, our quant, flow, and technical analysis all support our fundamental view. In particular, our quant report sees the USD bull trend snowballing. From a technical perspective we are bullish USD against most currencies. Flow and positioning metrics also support our fundamental view as USD-buying flows have started but overall positioning remains very light.
Forecasts: steady against G10
We make no changes to our G10 FX forecasts as improving data has made the market increasingly comfortable pricing in a hawkish Fed shift. This is in line with our view that continued labor market gains could lead to upside surprises in inflation, implying faster USD-positive Fed reduction in stimulus. Similarly in EM, there were no changes to key EM views.
Risks: weak wage growth
The main risk to our view is a period of continued low inflation and wage growth, leaving the Fed comfortable in their existing cautious stance and pushing out the timing and pace of eventual rate hikes, delaying the expect USD rally.
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