After three weeks of back to back losses, the dollar index received a boost following a robust U.S. jobs report. Not only did nonfarm payrolls beat expectations last month, rising by 209,000 jobs versus the expected 183,000, but June’s figures were also revised higher to 231,000 from 222,000. The unemployment rate also declined to 4.3% from 4.4%, and most importantly, average earnings growth accelerated by 0.3% for the first time since February. Fridays strong jobs report will pave the way for the Fed to start reducing the balance sheet in September, but markets are still not confident that a third rate hike will occur this year. According to CME’s Fedwatch, markets still believe that the chance of a rate hike in December is below 50%, and for this perception to change, it requires inflation to accelerate, after declining for five straight months. The week ahead will give us this information.
Both the producer price index and the consumer price index are due for release on Thursday and Friday. The CPI is what matters most to traders, and after declining from 2.7% in February to 1.6% in June, economists expect prices to edge up 1.8%. If inflation data suggests that prices are back on the rise, this will lead to revaluating the rate hike path, which strengthens the case for a December rate hike.
The U.S. dollar which suffered from steep losses in the past five months, looks extremely oversold, despite Friday’s rally. The Euro, Aussie, Swedish krona, and Danish Krone, are all up by more than 10% against the greenback in 2017. While much of the repricing occurred in response to hawkish tilts in global central bank rhetoric, I think the move was too fast, and we are likely to see some consolidation in the weeks to come. However, if U.S. inflation makes a U-turn and fiscal policy developments move on the right track, the dollar could have already found a short-term bottom.
I believe central banks such as the ECB and RBA will become more worried about the strength of their currencies. The Eurozone’s economic health is much better than most have anticipated in 2017, and no doubt, the central bank wants to prepare markets for tightening policy. However, if the Euro continues to appreciate from current levels, there will be many negative implications on the recovery, and this is why I believe the ECB will indirectly intervene in talking down the Euro. This is another reason why the dollar might have bottomed out on the short run.
The economic calendar is light in the week ahead, and many big traders and fund managers are off to enjoy the summer season. During such times, markets will become quiet, and trading volumes fall. This does not necessarily mean that we shouldn’t expect significant price fluctuations - a close eye should remain on Washington as continuing political drama may take center stage at any time.
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