US: FOMC action later this month to help dollar - MUFG

Derek Halpenny, European Head of GMR at MUFG, suggests that the monthly NFP report is always viewed as important but there is certainly a much higher chance of financial market volatility in the aftermath of tomorrow’s jobs report given the increased possibility that the FOMC may be willing to raise rates at the next meeting on 21st September.

Key Quotes

“The dollar was helped yesterday by the ADP employment report which revealed a 177k gain in jobs in August following an upwardly revised 194k increase in July. That’s broadly consistent with an NFP print tomorrow of around the consensus of 180k.

We believe a consensus type payrolls report tomorrow could well be enough to see the FOMC agree to raise the federal funds rate later this month. So far, the markets remain reluctant to price this scenario with the September federal funds future price implying a federal funds rate of 0.42%, four basis points above the middle of the current fed funds range of 0.25%-0.50%. We calculate a rate hike on 21st September would result in a settled Sept fed funds future price of 9945 (assuming effective rate remains a mid-point), which essentially implies only a 25% probability of a rate increase being currently priced. The lack of pricing in a September move is in part down to awaiting tomorrow’s report and points to the potential for some big moves if the jobs data is broadly consistent with the average payrolls gain on a year-to-date basis (186k).

With Fed Chair Yellen having stated that the case for a rate increase has strengthened in recent months and given that Vice Chair Fischer expressed the view that her comments were consistent with a “possible” move in September, we now believe the FOMC will act this month. The key assumption in bringing forward our timing for the next rate hike from December is that the data between now and 21st September is consistent with progress toward full employment and price stability. We think that’s a pretty low hurdle at this stage.

So there are clear upside risks for the dollar over the coming weeks. There is evidence indicating a weakening of correlations between FX spot rates and 2-year yield spread moves but if the market starts to price more seriously the probability of a September rate increase, we should see relative monetary policy come back as a more serious driver of FX – at least through to the meeting.”