Exhibit 1: Changes in US dollar index (DXY) between March 2015 and 06/09/18
Source: Bloomberg, BNP Paribas Asset Management, as at 06/09/2018
After weakening in 2017, the US dollar (on a trade-weighted basis against developed market currencies) embarked on a rally at the end of the first quarter of 2018 (Exhibit 1 shows the changes in the US dollar index (DXY) between 01/03/2015 and 06/09/2018).
Since the middle of August, the DXY has fallen. Is the dollar rally running out of steam?
Over the summer of 2018, markets pondered the idea that the US Federal Reserve may not, after all, raise policy rates as high as previously expected. Among other things, this idea was predicated on the continued absence of inflationary pressures (and particularly wage inflation).
Exhibit 2: During the summer of 2018, there was no catalyst to push US 10-year breakeven inflation rates through the level of 2.25% towards 2.40%
Changes in US 10-year breakeven rate; source: Bloomberg, BNP Paribas Asset Management, as at 06/09/2018
Data released on 07/09/2018 showed another strong performance by the US labour market in August. The average monthly increase in non-farm payrolls in 2018 is now 207 000, compared to 182 000 in 2017, reflecting a broader pick-up in economic momentum in 2018.
Exhibit 3: US non-farm payrolls data for August 2018 also revealed a relatively big 0.4% month-on-month increase in average hourly earnings
Source: Bureau of Labor Statistics/Haver Analytics, as at 31/08/2018
August 2018 saw the strongest monthly gain in average hourly earnings since June 2009. The previous weakness in wage inflation had puzzled policymakers. Further confirmation will be needed to convince policymakers that wage inflation is really taking off, but this data shows the US labour market to be in good shape.
Inflation-linked bond specialists at BNP Paribas Asset Management anticipate higher inflation in coming months
Our inflation-linked bond team anticipate US core inflation pressures will build incrementally in coming months, taking the year-over-year rate above the Fed’s 2.0 % target for PCE. Their view is that inflation pressures will be evident from ongoing wage gains, along with rising shelter and medical care prices.
However, our team is turning more cautious on inflation breakevens (BEI), given the Federal Open Market Committee’s (FOMC) reluctance to tolerate any significant and persistent inflation overshoots.
As a result, they have a neutral view on BEI. At the same time, while their baseline forecast is for US growth to strengthen in the second half of 2018 and for the FOMC to proceed with rate normalisation to offset the fiscal impulse, they are positioned for lower bond yields, given the continued concerns about Italy’s political and fiscal situation, and the threat of a trade war, which they expect will likely provide support to safe-haven markets.
August’s employment report is the last before the meeting of the FOMC on September 25-26. The August US employment data keeps the Fed firmly on track to increase its policy rate in September and then again in December 2018 (click here for the calendar of FOMC meetings).
US dollar bears may be frustrated after all…
For previous graphs of the week, click here.