USD stabilizes after more volatile trading at end of last week

USD: US labour market data adds to FX market volatility

The US dollar has stabilized overnight after a volatile session on Friday. The US dollar initially extended its recent rebound after the release of the stronger than expected non-farm payrolls report on Friday before giving back all of those initial gains after the release of the weaker than expected ISM services survey later on the day. Now the dust has settled the dollar index has returned to trading at levels that were recorded last Thursday prior to the economic data releases on Friday. The US dollar initially strengthened on Friday after the establishment survey revealed that the US economy added 216k jobs in December although the upside surprise was again offset by downward revisions to prior months job gains totalling -71k. After stripping out government sector job gains as well, the slowing trend for private sector job growth remains in place. Private payrolls increased on average by 134k/month in the second half of last year compared to 204k/month in the first half of last year. The slowdown in employment growth is even more notable in more cyclically sensitive jobs. After stripping out government, healthcare and education sectors, payrolls increased on average by just 40k/month in the second half of last year compared to 122k/month in the first half of last year. Despite the stronger employment figures for December those slowing underlying trends for employment growth should provide reassurance to the Fed that labour demand is weakening and becoming more aligned with supply to help ease upside inflation risks.

However, the household survey provided a less comforting signal for labour supply. It revealed that the participation rate dropped sharply by 0.3ppt to 62.5% as the labour force declined by -676k in December. It was offset by a similar sized drop in employment in the household survey by -683k which was the largest monthly drop since the COVID shock hit in early 2020. The household survey does tend to be more volatile than the establishment survey so it is probably best not to place too much emphasis on the scale of the moves in the employment and the labour force recorded in December at the current juncture unless repeated in the coming months as well. Average hourly earnings growth increased by 0.4%M/M for the second consecutive month which highlights that upside inflation risks from the tight  labour market are still a concern for the Fed. Overall, the report is unlikely to be sufficient on its own to encourage the Fed to meet market expectations for the first rate cut to be delivered as soon as March. The US rate market has since moved to further scale back March rate cut expectations and is now currently pricing in around -17bps of cuts.          

The US dollar initially strengthened as Fed rate cut expectations were scaled back but then gave back those gains quickly after the ISM services survey for December sent another warning signal over the strength of labour demand. The employment sub-component dropped sharply by 7.4 point to 43.3 in December. It was the largest drop in the employment sub-component since the COVID shock first hit in 1H 2020. Going back to 1998 there have only been three months where the employment sub-component dropped even more sharply back in November 2008, February 2014 and April 2020. On two of those occasions the US economy was in recession. The abrupt adjustment lower in the employment sub-component in December has challenged market expectations for a soft landing for the US economy. While one would normally put it down as a one off reading which likely exaggerates weakness in the labour market, it is not the only labour market reading that has weakened sharply recently. The JOLTS hiring rate also dropped notably in the latest report indicating a more marked slowdown in labour demand is potentially underway. It will ensure that labour market data will attract even more attention in the coming months.         

NOTABLE SLOWDOWN IN “CYCLICAL” EMPLOYMENT SECTORS

Source: Bloomberg, Macrobond & MUFG GMR

EUR: December pick-up in euro-zone CPI expected to prove short-lived

The release on Friday of the latest euro-zone CPI report for December confirmed that the annual rate of headline inflation picked back up to 2.9% from 2.4% in November. In contrast, the annual rate of core inflation continued to slow dropping by 0.2ppt to 3.4% in December. The pick-up in headline inflation is expected to prove short-lived. One can clearly see that inflation has slowed notably in the second half of last year. On a six month annualized basis, headline inflation slowed to 2.1% in the second half of last year compared to 3.7% in the first half of last year. A similar pattern is also evident for core inflation which has slowed to 2.1% in the second half of last year compared to 4.7% in the first half of last year. We expect the slower pace of inflation to continue in the first half of this year and to open the door for the ECB to begin cutting rates in Q2. In our latest Annual FX Outlook report (click here) released on Friday, we outlined that we are now expecting the ECB to deliver 125bps of rate cuts by the end of this year. It is one of the reasons why we expect the euro to strengthen only modestly against the US dollar in the year ahead as the Fed is also expected to be active in lowering rates to less restrictive levels in 2024. Our latest forecasts for EUR/USD show a more neutral profile for the pair in the first half of this year before it adjusts higher in the second half of this year up to towards the 1.1400-level by year end.        

KEY RELEASES AND EVENTS

Country	GMT	Indicator/Event	Period	Consensus	Previous	Mkt Moving
EC	09:30	Sentix Investor Confidence	Jan	-15.5	-16.8	!
EC	10:00	Consumer Confidence	--	-15.1	-16.9	!
EC	10:00	Retail Sales (MoM)	Nov	-0.3%	0.1%	!
EC	10:00	Unemployment Rate	Nov	--	6.5%	!!
US	17:00	FOMC Member Bostic Speaks	--	--	--	!!

Source: Bloomberg