Good news is bad news, as good economic data supports the idea that the US economy could withstand an aggressive monetary policy tightening, therefore has a boosting effect on the US yields, and a negative effect on equity valuations.
But, bad news is also bad news, as the Federal Reserve (Fed) is so determined to bring inflation down, that it is ready to accept a certain slowdown in economy, and the jobs market.
This is why yesterday’s softer-than-expected NFP data didn’t please investors much. The data showed that the US economy added 132’000 new private jobs in August. That was less than about 300’000 expected by analysts.
If Friday’s NFP data shows a similar slowdown in the US jobs market, we will start talking about a potential shift from super-resilient job growth to something more understandable, and more in line with the actual tightening macroeconomic conditions.
And this is something that the Fed ultimately wants to achieve, because a cooler jobs market should also lead to cooler inflation.
Equities extend losses
The three major US indices extended losses yesterday. The S&P500 lost close to 0.80%, Nasdaq dropped another 0.56%, while the Dow Jones was the most heavily hit.
Even the energy stocks couldn’t weather yesterday’s selloff, as crude oil fell close to 4%. The barrel of American crude is again below the $90 level on growing global recession worries and prospects of lower demand.
But if you ask OPEC, the decline in oil prices is due to the disconnect between the reality and the financial markets. So, if we see further declines, they will certainly remind us how tight the oil market could be, no matter how much the global demand slows.
Why inflation doesn’t boost the euro, as much as it boosts the US dollar?
The US dollar index remained strong despite the soft ADP data yesterday, showing how much the employment data doesn’t matter for the Fed expectations. High inflation continues fueling the US dollar, but the same is not true for other currencies like the euro and sterling. Eurozone and Britain are also dealing with skyrocketing consumer prices, but we can’t really say that their currencies are benefiting from that.
The European Central Bank (ECB) for example hiked its policy rates by a 50bp at its last meeting and is now expected to hike by a turbo 75bp in September, as the flash CPI read yesterday revealed that inflation in the Eurozone advanced past the 9% mark in August. The market now gives 60% probability for a 75bp hike.
But no one is impressed, as the Fed is also expected to hike by 75bp this month. Therefore, the ECB must do something bigger to get the market by surprise and to reverse the negative trend in the euro.
And that’s not a piece of cake. European policymakers can’t just raise the rates when the continent is dealing with a deepening energy crisis. It was much easier to shoot the rates to the ground than bringing them back on feet.
As such, even with the rising inflation and the hawkish expectations regarding the ECB policy, the euro is expected to extend losses below parity against the US dollar, simply because the Fed hawks have stronger muscles than the ECB, or the BoE hawks. As a result, the higher inflation doesn’t necessarily lead to a higher euro or a higher sterling. CQFD.
It’s also important to note that in period of high stress, like the one we are going through today with the pandemic, the war and the energy crisis, the US dollar becomes the go-to asset of investors.t The dollar also amassed the safe haven flows since last year, especially given that the sovereign bonds and gold couldn’t offer the protection that investors were looking for.
But, we also know that what goes up must come down. There should be a downside correction in the USD, but when, is the million-dollar question.
