Steady Payrolls, Flat Dollar: Can RMB, Yen Strength Last?

Recent data on non-farm employment in the United States has served as a sigh of relief for traders who had been on edge.Released on July 5,this highly anticipated report revealed that the U.S.economy created 206,000 new jobs in June,surpassing market expectations of 190,000.However,the unemployment rate ticked up from 4.0% to 4.1%,showing a minor increase that was also slightly above forecasts.Such mixed signals in the employment landscape painted a more complex picture of economic health.

Following the data release,financial markets responded positively: gold prices climbed,U.S.stocks saw a rise,and bond yields experienced a decline.The CME FedWatch Tool indicated that the probability of an interest rate cut in September rose to over 70%.Consequently,the U.S.dollar index slipped back to 104.5 after having surged to nearly 107 in recent weeks.There was also a notable rebound in the Japanese yen and Chinese yuan,with the USD/JPY pair retreating from a peak of 162 down to around 160.Meanwhile,the offshore yuan reached a high of 7.3115 against the dollar just days earlier but stabilized at around 7.2888.

Liu Yang,the general manager of the Financial Markets Department at Zhejiang Zhongtuo Group,articulated to reporters that after a period of substantial appreciation in the U.S.dollar,traders seemed inclined to take some profits.Consequently,they have started to show less sensitivity to certain data releases.He noted that the decline in the dollar index appeared more influenced by short covering in the euro,highlighting that while the RMB exchange rate is on the rise,a large-scale unilateral movement is unlikely in the near future.

Expectations continue to grow regarding a possible interest rate cut in September.Over the past month,the strong U.S.dollar has placed significant pressure on Asian currencies,partly fueled by uncertainties surrounding European elections that previously triggered a “short squeeze” resulting in the dollar index climbing to 107.However,recent improvements in European conditions,along with signs of cooling inflation and employment data in the U.S.,have solidified expectations for a rate reduction.

Although the June non-farm data may not look poor on the surface,it reveals a stark contrast with May’s numbers,which exceeded expectations by nearly 100,000 jobs amidst concerns about potential rate hikes later in the year.The three-month average job growth fell sharply from 249,000 to 177,000,suggesting a slowing trend.Additionally,the sectors contributing to job growth in June were somewhat uninspiring,with healthcare and government accounting for three-quarters of job creation while cyclically sensitive industries,such as retail and manufacturing,reported job losses.

The unemployment rate increased by 0.1 percentage points to 4.1%,even as the labor participation rate edged up to 62.6%.Salary growth pressure also appeared to be abating,with average hourly earnings rising 0.3%,aligning with expectations.

Goldman Sachs remarked post-release: "We maintain our forecast that the FOMC will initiate interest rate cuts in September,followed by quarterly reductions,ultimately bringing the terminal rate to a range of 3.25% to 3.5%." Currently,the federal funds rate ranges between 5.25% and 5.5%.

Furthermore,Chen Dong,the chief strategist and research director at Swiss financial firm Pictet,mentioned that weaker consumer spending and a cooling labor market could lead to a slowdown in U.S.economic growth in the latter half of the year.He projects that the Federal Reserve will cut interest rates by 25 basis points in both September and December.He also noted that the Eurozone,including Germany,appears to be staging a mild recovery,prompting an upward revision of its GDP forecast for the year.

As discussions surrounding the possible end of the strong dollar era unfold,uncertainties complicate the scenario,particularly with the upcoming U.S.elections in the second half of the year.Eric Robertsen,chief strategist at Standard Chartered,emphasized how political events often overshadow other market considerations,driving volatility,especially in foreign exchange markets.

“The dollar has benefitted from rising real yields and robust financial market performance,with the S&P 500 outperforming the MSCI Emerging Markets Index by nearly 10 percentage points since the beginning of the year.However,the excellent performance of the stock market may reverse due to election-related uncertainties,” Robertsen explained.He added that before the presidential election in November,potential volatility from global elections might fuel further dollar strength.

Despite indications of economic cooling,the inventory cycle appears to be on the upswing,hinting at a recovery in manufacturing.Chen indicated that there is increasing evidence of a rebound in manufacturing across developed economies,driven in part by the inventory cycle following significant disruptions caused by the COVID-19 pandemic.Businesses may have been overly cautious in building inventory to meet future demand,potentially leading to a recovery that is driven by inventory without undermining ongoing disinflationary efforts.

Liu Yang also pointed out that before the U.S.CPI data release next week,if the dollar index can stabilize near its support level,a rebound from the 104 position may not be out of the question.

After the non-farm payroll data was released,both the yuan and the yen experienced rebounds.However,sentiment for the yen remains predominantly bearish,given its heavy depreciation to a low of 162 against the dollar on July 4,coupled with the lack of intervention by Japanese authorities in the foreign exchange market.

Short-term forecasts suggest that it is unlikely for Japan to intervene in the forex market.Matt Weller,global research director at Gain Capital,highlighted that a transition in top currency officials was imminent,with long-time FX chief Kanda Makoto being succeeded by Jun Mitamura at the end of July.Additionally,October is anticipated to be another observation period for potential rate hikes by the Bank of Japan,suggesting continued bearish sentiment toward the yen in the meantime.

“Kanda's direct interventions in the forex market gave rise to a total expenditure of $62 billion,yet their efficacy was minimal.Market speculation now leans toward Kanda being perceived as a 'lame-duck' policy maker less likely to intervene further as his tenure nears an end.Given the interest rate differential exceeding 5% between the U.S.benchmark and Japan’s objective rate,the bullish trend for USD/JPY may persist,with a focus on the 165 level as a critical threshold for intervention,” Weller elaborated.

As for the Chinese yuan,there is an expectation that stability will prevail in the short term.Lian Ping,the chief economist of the Chief Research Institute at Guangfa Securities,stated that the stable surplus in China’s current account would provide robust support for the yuan.With this context,a rate cut by the Federal Reserve could signal strength in the yuan’s exchange rate,potentially leading to a gradual trend upward in the second half of the year.

Recently,although the midpoint of the yuan against the dollar fell below 7.12,it continues to reflect a strong position nearly 1000 points above the spot trading price,approaching the upper limit of a 2% fluctuation range.This illustrates efforts by the People’s Bank of China to maintain exchange rate stability.

Lian suggested that throughout the latter half of this year and into next year,a suitable relaxation of the dual-direction fluctuation range of the exchange rate could be in order.He advocates for a balanced selection among objectives like economic growth,full employment,price stability,and international balance of payments to buffer external shocks and enhance the efficacy of demand management policies as well as monetary supply controls.

He projected that the likelihood of reserve requirement cuts may surpass that of rate cuts this year,though both remain possibilities.There may be adjustments to the seven-day reverse repurchase rate by about 10 basis points to guide main policy rates,and a downward revision in the Loan Prime Rate of 10 to 15 basis points could be anticipated without altering the Medium-Term Lending Facility rate.

In summary,the fluctuations in U.S.employment data and its implications for inflation,monetary policy,and currency valuation weave a complex narrative of uncertainty and strategic positioning in the financial markets,impacting everything from local economies to global supply chains.