Strong growth in jobs unlikely to sway ‘hawkish’ US Fed stance
Federal Reserve not too keen to increase interest rates when others are cutting it across the world
Friday’s forecast-smashing 255,000 rise in US July non-farm payrolls understandably drove both a knee-jerk rally in the value of the dollar and an uptick in expectations of a rise in US interest rates when the US Federal Reserve next meets in September. But things are not quite that simple.
While the actual rise in the July non-farm payrolls massively exceeded analysts’ expectations of an increase of 180,000, and even though the already-bumper June figure was revised up to 292,000, there is another set of jobs data for the US central bank to analyse at the start of next month before it meets on September 20 and 21. Indeed the US Fed may anyway have other ideas.
“The US Fed has been evasive and time-inconsistent,” wrote Stephen Li Jen of macro investment company Eurizon SLJ Capital on Friday, adding that “there are always reasons for them not to take actions.”
Jen concludes that “the most efficient and effective strategy may be to assume that the US Fed will not hike, as they modify their reaction functions to keep the dollar from appreciating.”
Dollar policy is officially the preserve of the US Treasury but Jen may have a point.
William Dudley, president of the New York Federal Reserve stated in a speech made in Bali on July 31 that , “the US Federal Reserve is not targeting the exchange value of the US dollar,” and US interest rate setters are clearly not oblivious to it.
“If the economic outlook abroad deteriorates and this causes foreign countries to pursue a more accommodative set of monetary policies, then the dollar would likely appreciate―other things equal, reflecting expectations of lower interest rates abroad relative to US interest rates,” Dudley said.
“In this case, the US may need to adjust its own monetary policy path. If the [US Fed] did not make this adjustment, the stronger dollar could result in an undesired tightening of US financial conditions,” Dudley added.
Making the point that “the expected forward interest rate paths in Europe and Japan have fallen considerably this year” Dudley argued that if the US Fed had stuck to its median path for the federal funds rate, based on its December 2015 projection, “then the US dollar would likely have appreciated much more significantly.”
In the post-Brexit environment of uncertainty in the United Kingdom, last Thursday’s decision by the Bank of England to cut interest rates to an all-time low of 0.25 per cent and resume bond purchases put renewed downward pressure on sterling versus the dollar.
In the euro zone, European Central Bank executive board member Benoit Coeure argued on July 28 that, “the impact of negative rates, combined with the asset purchase programme and forward guidance, has clearly been net positive” and that “it seems possible that [rates] will be low for quite some time.”
The US Fed will take both of those factors into account based on the tone of Dudley’s comments in Indonesia.
As regards the yuan, perhaps the US Fed can, for the moment, take some cheer from the fact that Beijing now targets the value of China’s currency versus a basket of other currencies and not just the dollar.
Also, Beijing will likely want a stable yuan ahead of September’s G20 meeting in Hangzhou and with the yuan’s official debut as a component of the International Monetary Fund’s Special Drawing Right on October 1.
Meanwhile in Japan, markets seem to have concluded that the latest round of Bank of Japan monetary easing and the Abe government’s new fiscal stimulus plan represent cases of over-promising and under-delivery.
As yen weakness has been a characteristic of Japanese monetary and fiscal policy settings collectively referred to as Abenomics, any perceived under-delivery on that policy front lends itself to a rise in Japan’s currency versus the greenback.
Yen strength against the greenback, given the size of Japan’s economy relative to Britain’s, should cancel out sterling weakness, if the US Fed is taking heed of the dollar’s external value as it calibrates US domestic interest rate policy. But it also reinforces the idea that markets cannot currently take US economic data in isolation.
Elsewhere, the US Fed will also be aware that the greenback could rise further versus the Canadian dollar given Friday’s poor jobs data in Canada and the broader negative implications of a lower oil price on Canada’s energy sector.
Friday’s buoyant US payroll data may have increased the chances of a US rate hike and fueled a rise in the value of what was previously a somewhat friendless dollar but that still doesn’t mean the US Fed will necessarily play ball and tighten policy just yet.