The US Dollar Extends Losses after Unemployment Posts Surprise Increase and Wages Data Disappoint in June

-USD eases lower after FOMC minutes, wages data disappoint markets.

-Jobs rise faster but wages slow and unemployment increases in June.

-US/global growth and interest rate divergence theme is key for USD.

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The Dollar extended losses Friday after minutes from the latest Federal Reserve meeting failed to provide any fresh impetus for the greenback and as traders responded to a mixed June jobs report that has served only to further muddy the outlook for the US currency.

US nonfarm payrolls rose by 213,000 during June which, although down from 223,00 in May, was ahead of the consensus estimate for jobs growth of just 195,000. However, and on the downside, the unemployment rate posted a surprise increase during June and the rate of average hourly earnings growth surprised on the downside. 

The US unemployment rate rose to 4% last month, up from 3.8% in May, when markets had looked for it to hold steady at a post-crisis low of 3.8%.

The Bureau for Labor Statistics said there were 499,000 more unemployed workers in the US during June than there were back in May, which took the total number of unemployed to 6.6 million. A year earlier, the jobless rate was 4.3 percent, and the number of unemployed persons was 7.0 million.

However, a closer look at the data shows the unemployment change is due to a rise in the level of participation, with more previously-discouraged workers enetering the labour force once more during June. This can increase the number of workers who are classed in the statistics as being unemployed, without there actually being an increase in joblessness.

Meanwhile, average hourly earnings grew by just 0.2% last month when markets had been looking for an increase of 0.3% to take the annual rate of wage growth up to 2.8%. Instead, annual growth was steady at 2.7%, suggesting wage pressures are slower to build than economists had previously thought. 

"Both hiring and labour force participation showed up healthy in June, but it was another somewhat soft wage print which at least initially caught the eye of markets," says Royce Mendes, an economist at CIBC Capital Markets. "Despite the disappointment on wages, today's employment readings are in line with our healthy growth estimate for the quarter."

Mendes says the Federal Reserve is looking for annual US wage growth of between 3% and 4%. Once hourly earnings are rising at this faster pace then policymakers could become concerned about a possible future increase in inflation, with consequences for interest rates and the US Dollar. 

Above: Pound-to-Dollar rate shown at daily intervals. Covers 2018.

The US Dollar index was quoted 0.26% lower at 94.15 following the release after extending an earlier 0.07% loss and is now up just 1.97% for 2018. The Pound-to-Dollar rate was 0.31% higher at 1.3262 while the Euro-to-Dollar rate was 0.50% higher at 1.1750 after both extended earlier gains.

Above: Euro-to-Dollar rate shown at daily intervals. Covers 2018.

Markets care about the labour market data because falling unemployment and improving job creation, according to conventional thinking on the subject, put upward pressure on wages. Wage growth itself leads to increased demand within an economy and exerts upward pressure on inflation, which has implications for interest rates and financial markets.

Changes in interest rates, or hints of them being in the cards, are only made in response to movements in inflation but impact currencies because of the push and pull influence they have on international capital flows and their allure for short-term speculators.

"We continue to look at the average hourly earnings series more than the payrolls change numbers, as one would expect the latter to begin declining anyway as theoretical maximum employment (at least for those looking for a job) nears," says John Hardy, chief FX strategist at Saxo Bank. "The participation rate drop has flattered the headline unemployment rate number over the last couple of months, and we see the unemployment rate as providing the least important signal unless it registers a steady 3.8% level or drop."

The Dollar has converted a 4% 2018 loss into a 2.8% profit during the two months since the middle of April, following a sustained rally that drew a line beneath the greenback and a prior 12-month period of heavy losses.

Most analysts now agree that superior levels of growth have bolstered the case for the Federal Reserve to keep raising its interest rate, at a time when the interest rate outlook elsewhere in the world is deteriorating, which has incentivised traders to sell other developed world currencies and buy Dollars.

"The Fed showed increased confidence in their monetary policy guidance given the strength of the economy but also put greater emphasis on the largest downside risk for the global economy – escalating trade tensions. Those fears, reported by “many districts”, have now surely escalated after China promised like-for-like retaliation," says Derek Halpenny, European head of global markets research at MUFG.

Those arguing for further US Dollar gains and further Fed rate rises are increasingly being challenged by President Donald Trump's trade policies.

The White House is pursuing restrictive legislation to govern Chinese investments into the United States and recently ordered a range of tariffs be levied against imports of more than $250 billion in imports of Chinese goods.

The latest tariffs came into force on Friday, drawing an immediate pledge of retaliation from China that could merely beget an even heavier response from the US. US trade representatives said last month they would implement tariffs on another $200 billion of Chinese goods if it responds to the latest levies. 

"As this escalation unfolds, it will be all eyes on the USD/CNY rate. The recent weakness of the Chinese economy could see further upward pressure which will have some impact on keeping the dollar firm elsewhere. Maybe nobody wins in a trade war but the current strength of the US economy puts the US in relatively better position than most for now," Halpenny adds.

Trump has also placed tariffs on all imports of steel and aluminium from China, Canada, Mexico and the European Union. He is seen as attempting to reduce the US trade deficit after citing it repeatedly as a sign of malpractice by other countries and evidence that protectionist action is needed by the White House.

The moves so-far have drawn retaliation and threats of even further reciprocal measures from the Chinese, which all comes on top of earlier White House tariffs on imports of steel and aluminium into the United States from across the globe, including the European Union.

The EU has since responded with its own levies on US motorcycles, jeans and whiskey, drawing threats of even more tariffs from the White House, this time targeting the mighty European automotive sector.

Fears are that a tit-for-tat tariff fight between the world's largest economies will quickly descend into an all out "trade war" and that this will dent economic growth in all countries it touches, which could stymy the Federal Reserve from raising its interest rate further while also denting the odds that other central banks will be able to raise their rates any time soon.

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