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A weak September payrolls report has pushed back October Fed hike bets, taking the edge off the dollar.
The dollar's three-week rally has hit a wall in the form of a soft US jobs report, giving the pound room to recover.
The pound-to-dollar exchange rate rises to 1.3231 on Friday afternoon, lifting further off the 1.32 floor it has defended this week.
The US economy added just 29,000 jobs in September, well short of the 90,000 consensus, according to the Bureau of Labor Statistics.
The details were equally soft:
• July and August were revised down by a combined 60,000 jobs
• The unemployment rate rose to 4.2% from 4.1%
• Average hourly earnings rose 0.1% on the month, below the 0.3% consensus, slowing annual wage growth to 3.0%
Markets now see roughly a one-in-four chance of a Federal Reserve hike on 28 October, down from around 70% a week ago.
"Weak numbers in the employment market today will add to the chance that the Fed holds rates in October before assessing further data as it comes in," says Richard Carter, Head of Fixed Interest Research at Quilter Cheviot.
The report lands on a Fed leadership that has already been signalling patience.
Vice Chair Philip Jefferson said on Thursday that policymakers "will need to come to our own judgment, which may take more time", following New York Fed President John Williams' remark earlier in the week that there is "no need for urgency."
A Crowded Dollar Trade
The dollar went into the release looking stretched.
The dollar index rallied in all but four sessions from 9 September, gaining more than 3.2% over the period.
"Given that the market is already long dollars, we suspect a weaker number would be a large enough catalyst to cause weaker long positions to unwind," says Sarah Ying, Head of FX Strategy at CIBC Capital Markets, in a pre-release note.
Ying looked for the dollar index to fall back towards 101.00 on a modest miss, with a larger miss warranting a return towards the 100 handle.
Monday's week ahead forecast flagged the dollar rally as due a breather, and the payrolls report has supplied the trigger.
"The dollar is slipping and Treasury yields are down slightly across the front of the curve as traders price a more gradual series of rate hikes in the months ahead," says Karl Schamotta, Chief Market Strategist at Corpay.
Schamotta notes the British pound, Canadian dollar and Japanese yen are among the majors advancing as rate differentials narrow.
US yields fell between 6 and 9 basis points across the curve in the wake of the release.
Daniella Arcadipane, Senior Currency Specialist at Indigo
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Talk to a specialistWhy the Move Is Limited
The dollar's losses have been measured, however.
Schamotta points to an asymmetry in the Fed's reaction function: breakeven employment growth is seen around 50,000 a month, and inflation is of far greater concern to policymakers than jobs.
"One softer payrolls print is unlikely to be enough to convince policymakers that the labour market is undergoing a sustained deterioration," says George Brown, Senior Economist at Schroders.
Brown still expects the Fed to unwind last year's rate cuts, with the bigger question being whether rates need to move into genuinely restrictive territory.
CIBC's Helen Lao says the unemployment rate remains low despite the softer hiring, which makes mid-month September CPI data a crucial input for the October meeting.
Berenberg sees the report as a turning point for the rates narrative.
"The soft US labour market report for September challenges the story that a fresh global hiking cycle is necessary to contain inflation," says Andrew Wishart, Senior Economist at Berenberg.
The market still prices almost three more 25 basis point Fed hikes, while Berenberg expects just one.
The Rate Gap Turns Towards Sterling
The pound benefits from the contrast with the Bank of England, where the outlook for a November hike remains intact.
Money markets price around 19 basis points of Bank of England tightening for the 5 November meeting, against just 5 basis points from the Fed in October.
The Bank's September Decision Maker Panel, published on Thursday, showed firms' one-year-ahead inflation expectations rising to 3.3% from 3.1%, keeping pressure on the Monetary Policy Committee to act.
A Fed on hold and a Bank of England moving towards a hike narrows the rate advantage that has driven the dollar's September rally.
Europe Still Weighs
Part of the dollar's recent strength has come from Europe rather than the US.
"We suspect that fiscal risks in the EU is a large reason why the US dollar has been so strong of late," says Ying.
French ten-year borrowing costs sit around 150 basis points above German equivalents, and the euro has struggled even after Eurozone inflation rose to 3.8% in September, a three-year high.
That leaves the pound better placed than the euro to benefit from any dollar retreat.
US CPI data in mid-October now carries the weight of the Fed's October decision, and a soft print would extend the pound-to-dollar rate's recovery from 1.32.
Daniella Arcadipane, Senior Currency Specialist at Indigo
Moving a life-changing sum abroad? You won’t be doing it alone.
One specialist explains every step in plain English and stays with it until the money lands. FCA authorised, FRN 594433.
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