Safe-haven currencies soar on fears of US recession
A weak US labour report validated fears that the US economy is slowing down faster than the Federal Reserve expects or wishes.
Highlights:
USD sinks after soft July nonfarm payrolls report.
Fed seen cutting rates aggressively in 2024 amid US recession risk.
BoE delivers 25bp cut but signals gradual easing.
JPY rallies sharply on narrowing rate differentials.
EUR/CHF slides to February lows on safe-haven rally.
AUD struggles on soft CPI data, RBA meeting eyed.
Markets rushed to price in more cuts from the Fed this year, including the definite possibility of 50 basis point cuts. In addition, risk assets plummeted, and safe currencies soared, led again by an explosive performance in the Japanese yen, up 5% against the dollar in a single week after the Bank of Japan hiked rates and carry traces continued to be unwound. Emerging market currencies put in another dismal week, save for Asian ones, which are benefiting from yen and yuan strength as bearish bets against those currencies continue to be exited.
In just two short weeks, the market’s view for central bank moves have shifted significantly. Expectations for Fed cuts have gone from barely two to the equivalent of five 25 bp cuts, while bets for the ECB and the Bank of England have undergone less dramatic, but still meaningful, adjustments. The US dollar is suffering from this relative repricing, although its safe-haven role has kept the sell off quite mild so far. This week is one of the quietest of the year, given a dearth of economic reports or central bank meetings. It is likely that markets are overreacting somewhat to last week’s weak payrolls report out of the US, and we may see some countertrend moves.
USD
The US payrolls report for July was unambiguously weak, with low headline job creation (114k vs. 175k), another increase in the unemployment rate to 4.3%, its highest level since October 2021, and weak wage growth (3.6%). The data seemed to take the Federal Reserve by surprise, as while the FOMC strongly indicated that a September cut was on the way, it gave no hints of an accelerated rate cut timetable following its meeting last week.
We think expectations for cuts, which are now pricing in the equivalent of five full 25bp cuts (125 basis points) for the remainder of 2024, implying a couple of 50 basis point cuts, are an overreaction to what is so far the first weak labour market report of 2024. It does seem clear that in the absence of first-tier data out of the US this week, the dollar may struggle.
EUR
The weak US labour data caused a massive move in interest rate differentials between the US and the Eurozone, as expectations for European Central Bank rate cuts changed a lot less than the Federal Reserve’s. This has triggered another leg upwards in EUR/USD in the past few trading sessions, with the common currency surging back through this morning to its strongest position since March.
Eurozone inflation and second quarter GDP growth both came out stronger than expected last week. This has further kept the repricing of ECB rate cuts under control, and the euro well supported amid thin summer trading. This week is an unusually quiet one in the single bloc, so expect the euro to be driven largely by expectations for Federal Reserve interest rates.
GBP
The Bank of England cut rates by 25 basis points last week, as we and most strategists expected, although the vote was a very balanced 5-4 in favour of an immediate cut. The move was seen as ‘hawkish cut’, however, as the MPC refused to commit further or provide any forward guidance, although it did warn that it would not cut rates too fast or too deep. We think that this is consistent with cuts at every other meeting, with the next one likely to follow in November.
Sterling held up quite well amid market volatility and a generalised flight to safety, ending the week within 0.5% of where it began it against the dollar and down a bit more against the euro. No news of note will be released in the UK this week, but we continue to think that resilient demand, relatively high rates and the prospects for closer UK-EU relations bodes well for the pound.