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Back to the future for the US dollar

By John J. Hardy, Head of FX Strategy, Saxo Bank A/S

Until the January US jobs data was released on Friday, February 6, the currency market had gathering doubts on whether the US recovery is strong enough or the market environment supportive enough to ever trigger a rate hike from the Federal Reserve. After a number of weak secondary US economic data points in January and the obvious risk of very low inflation in the near term from the US from collapsing oil prices and a strong USD, the market had once again pushed the first anticipated Fed rate hike all the way out to around the September 2015 FOMC meeting. And this came despite a notable shift to the hawkish side at the December FOMC meeting and a misinterpreted January FOMC meeting statement, in which the Fed merely noted that it is watching the international environment as a factor in deciding when to raise rates, even as it upgraded its assessment of the strength of the US labor market.

But the January US employment report changed everything. First, the release of the January change in nonfarm payrolls data slightly beat expectations as it showed the US economy adding 257k new jobs in the month. This was about 30k more than expected, but on top of this, the November and December payrolls data were revised massively higher, showing a growth of almost 150k more new jobs beyond the original estimates. November, in fact, was one of the strongest months for US jobs growth in the last twenty years. As well, a strong rise in average hourly earnings and an upward revision of weak December earnings numbers laid fears to rest that US workers face weakening wage growth.

The market is ignoring strong US data at its own peril, having been too focused on what is going on in the rest of the world in central bank policy terms. The assumption has perhaps been that the crazy BoJ experimentation with monetary base expansion, QE finally coming to Europe, and recent rate cuts in Australia and Canada are rubbing off on the Fed’s potential to ever hike rates.

And it’s easy to understand this thinking – after all, as I can’t remember who recently pointed out, no professional in the finance industry under the age of 30 has ever seen a Fed rate hike, as the last one took place almost nine years ago. It hasn’t paid to believe in a hawkish Fed. But we will see a Fed rate hike soon. If we see a strong US jobs growth in February, look for the FOMC to begin signalling a rate increase at its June meeting, and if the jobs market continues improving at its recent pace, the Fed is way behind the curve on how much it will need to tighten in the near term.

And the market is even further behind the curve on the implications for the US dollar. It looks to me as if the USD rally is fully back on track. The FOMC cares far more for its dual mandate at home – full employment and inflation – then it cares that the US dollar is used as the world’s reserve currency and that tighter USD liquidity after the end of QE and on eventual rate hikes risk in inflicting massive pressures on emerging markets and China.