Morning Brief – False Illusions

Charles Porter
Fri 6 Jan 2023

alse Illusions

On Friday last week markets had got very exuberant over comments made by the Federal Reserve Chair the day prior. As a result of the interpretation of those comments, the US Dollar had dropped several cents to trade at its recent lows. There was a narrative that was being pieced together and justified that the end of the US tightening cycle could be drawing ever closer. There is definitely some truth to that narrative and we are approaching the time where US rates will peak and begin to reside. However, it seems the market may have got somewhat carried away last week and overreacted to any forthcoming shift in policy. 

When the non-farm payroll data dropped on Friday afternoon that illusion rapidly disintegrated. As a result of it being revealed that a mere sixty-three thousand jobs in excess of the forecast were created in the US in November, the Dollar came surging back from its newfound weakness. Of course employment will play a role in determining when the peak of US rates is reached for two reasons. Firstly, the age old inverse relationship between unemployment and inflation will directly impact the Fed’s primary price level mandate. Secondly, thanks to the Fed’s broad mandate, stronger employment figures can justify stronger inflation tackling measures. However, such a small out performance in non-farm payrolls should not move the US Dollar as much as it did. The reason for this overreaction is that the US Dollar was most likely overpriced versus fundamentals moving into the data release.  

The Dollar immediately rose in excess of one cent versus the Euro. The Dollar held onto the gains made on the back of the non-farm payroll data for much of Friday’s afternoon trading session. However, much if not all of that price surge in the Dollar had been eroded by the time European markets opened again yesterday. What can be taken forward from this event is that the market continues to fixate upon data, adding to the potential volatility we could see. It should be said that what had been fuelling USD weakness was not just the expectations for a Fed pivot. Expectations for the reopening of the Chinese economy and a dropping of the Covid-zero policy rules has been creating a risk-off environment where the Dollar can fall. 

Discussion and Analysis by Charles Porter

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