The week ahead: Looking to NFPs and what’s next for the dollar

There are two key things on the agenda this week, firstly, when will the dollar’s sell off come to an end, it fell to its lowest level in more than two years on Monday, and secondly, will the US jobs data suggest that the US economy is recovering from the Covid pandemic. In the middle is the usual release of the start of the month data, with global PMIs for August, along with European inflation reports, UK lending and mortgage data and US house price data also worth watching. 

Lower, lower, lower for the dollar 

Looking at the dollar first, the dollar index is hovering just above 92.20, its lowest level since May 2018, as the market continues to adjust to the Fed’s policy shift and selling the dollar is the FX market’s favourite momentum trade. The wind is certainly behind the recent decline in the dollar, and at this stage in the sell-off it’s hard to see where support might hold, such is the weight of opinion against holding the dollar right now. 88.80, the low from January 2018, is a key long-term support if the dollar sell off continues over the next few weeks, in the shorter term, below 92.00 opens the way for sharper sell off back below 90.00. The technical indicators are not yet suggesting that the dollar is oversold, thus there could be more downside for the greenback this week. 

Why we fancy the pound’s chances right now 

EUR/USD has been a key beneficiary of the recent dollar weakness, and EUR/USD is trading at a near 2.5 year high. $1.20 is only 70 points away at this stage, and it is hard to see much resistance at this key level. Above here, $1.2330 and then $1.25 come into view in the medium to longer term. GBP/USD is also worth watching, technical indicators suggest that this pair is still a strong buy, and after rising 300 pips in the last 5 trading days, it is easy to see why. GBP/USD has met some resistance ahead of $1.34, how this pair reacts over the next 24 hours is worth watching closely. It is worth noting that political factors remain negative for the pound right now: post Brexit trade deal negotiations are going nowhere fast, and there is a chance that in December the UK could end up without a trade deal with Europe and have to resort to World Trade Organisation rules. Added to this the newspapers are awash with stories about potential tax rises that may be included in November’s Budget. Both of these events could be bad news for the pound, although here at Minerva we tend to be more bullish on the pound in the medium term and see a return to $1.36 vs. the USD in the coming weeks. We also believe that trade negotiations and the potential tax increases may have a larger negative impact on the FTSE compared to the GBP right now. In recent days, GBP has outperformed the euro, and EURGBP has been trending lower, and is currently below £0.90. This is one reason why we favour GBP/USD over EUR/USD in the shorter term. Added to that, the UK’s Covid infection rate continues to be significantly lower than parts of Europe, which could keep the UK’s economic recovery on a better track than the Continent’s. 

What’s up with USD/JPY? 

Elsewhere, the dollar has fallen against the safe haven currencies, although the depth of losses has been mixed. For example, it has collapsed versus the CHF, and is back at 2015 lows, however, it has held up vs. the JPY, where it is only back at early August lows around 105.90. This is partly due to the yen’s relative weakness. The Japanese currency has also struggled to gain traction in recent weeks, partly this is due to the unwinding of other yen trades, such as EUR/JPY, which is at a 1.5 year high, and GBP/JPY which is at its highest level since February. The resignation of Japan’s prime minister late last week on health grounds, is also a reason for the yen’s underperformance vs. the USD. Overall, we expect the USD to break lower vs. the yen, and if we continue to see broad based USD decline then this will only be a matter of time. Potentially 100.00 could be on the cards when the breakdown occurs.

Finding cracks in the weak dollar narrative  

It is worth looking at reasons for the dollar’s weakness and trying to find any cracks in the argument that says that the dollar could fall further. We believe that the dollar’s weakness is due to the decline in short term US Treasury yields. The yield on the 2-year Treasury bill is 0.11% and remains mired close to all-time lows since the pandemic began earlier this year. The differential between the 5-year and 30-year yield is 120 basis points, the widest it has been since January. The steepening of the US yield curve is also negative for the US dollar, as it anchors short term yields at a low level. The announcement from the Fed that it would ignore inflation, even if it runs above its 2% target, and instead focus on the wider economy when it is setting policy, has firmly anchored the short end of the US yield curve at a low level for the long haul. All of this has happened when 30-year yields are still a mere 1.44%, thus it is easy to see why the dollar is falling and US stocks are rising – we are in a low yield environment for the long haul. Added to this, the FX market tends to fixate on one theme, and even if you think that the speed of the dollar sell off is too fast and that there should be some respite for the greenback, momentum is on the side of a weaker dollar, and this could remain the case for some time. 

The dollar and payrolls 

We believe that it is a brave man who takes the other side of the prevailing dollar trend in the short term, however, dollar bulls may be get a chance to express themselves later this week when we get the US Labor Market report for August. We will write about this in more detail later this week, however, for now, it is worth remembering that the Fed’s change in policy, formally announced last Thursday, suggests that policy will be more dependent on economic data than ever before. A weak labour market report means that the dollar is likely to stay low, however, a surprise upswing in the jobs data suggests that the dollar could stage a recovery. Right now, the market is expecting 1.4mn new jobs to be created for August, and for the unemployment rate to improve slightly to 9.8%. While this would be a sign of improvement in the US labour market, we believe that if the US jobs data does come in close to these estimates, it will be enough to keep the Fed dovish for some time and the dollar in the doldrums for some time yet.