Can Nonfarm Payrolls Reawaken the U.S. Dollar?

Forex

Summary:

The latest edition of nonfarm payrolls will be released at 12:30 GMT Friday.

The latest edition of nonfarm payrolls will be released at 12:30 GMT Friday. Early indicators point to another solid employment report, which would reaffirm that the U.S. economy remains far stronger than its competitors. This strength has not been reflected in the dollar lately, as other central banks raced ahead of the Fed in raising rates, although this dynamic seems to be changing.

Economic resilience

It is becoming clearer that the U.S. economy has withstood the burden of higher interest rates without sustaining any real damage. Economic growth is running at around 2%, consumption remains robust, and the labor market is in great shape.

Even the housing market has staged a recovery, which is impressive in an environment where mortgage rates are almost 7%, restricting access for first-time buyers. And while the broader economy remains resilient, inflationary pressures seem to be moderating with some assistance from falling energy prices.

Can Nonfarm Payrolls Reawaken the U.S. Dollar?_1

As such, recession concerns have faded away and there are growing hopes that the U.S. economy can achieve a soft landing. In sharp contrast, business surveys warn that the European economy is descending into a recession, while the Chinese economy has been kneecapped by the slump in global manufacturing.

NFP might slow down, but nothing tragic

Turning to this week's releases, the ball will get rolling on Tuesday with the ISM manufacturing survey for July. The non-manufacturing index will follow on Thursday and will provide important clues around how the labor market performed, ahead of the official employment report on Friday.

Nonfarm payrolls are projected to have risen by 200k in July, which is a shade lower than last month's 209k. The unemployment rate is expected unchanged at 3.6%, while average hourly earnings are seen losing some steam, slowing down to 4.2% from 4.4% in the previous month.

For the most part, these forecasts are corroborated by early labor market indicators. Applications for unemployment benefits fell during the month, which suggests there were no signs of mass layoffs. Meanwhile, business surveys revealed the slowest pace of employment growth since January, but admittedly, that's not very worrisome since it's been a stellar year for jobs growth so far.

Can Nonfarm Payrolls Reawaken the U.S. Dollar?_2

One area that might hold surprises is wage growth, as the same businesses reported rising salary pressures amid challenges to retain staff. Hence, the risks surrounding the average hourly earnings print might be tilted to the upside.

A generally hot employment report – especially on the earnings front – could fuel bets that the Fed is not done raising rates and by extension help to revive the U.S. dollar. Looking at the euro/dollar chart, the most crucial area to watch on the downside is the 1.0940 region, which is the 50% Fibonacci retracement of the entire 2021-2022 downtrend.

On the other hand, any disappointments in the jobs data could inflict some damage on the dollar and propel euro/dollar higher, turning the spotlight towards the 1.1090 territory.

Investors will get a better sense of what to expect on Wednesday and Thursday, when the ADP employment data and the ISM services survey are released, respectively.

The big picture

All told, the outlook for the U.S. dollar seems increasingly bright. The U.S. economy is far superior to its competitors at this stage, which ultimately might be reflected in the FX arena.

Market pricing currently suggests that the Fed is likely to cut interest rates before the ECB does next year, even though the European economy is already struggling. This leaves some scope for a repricing in bond markets, something that would be negative for euro/dollar if it plays out.

Can Nonfarm Payrolls Reawaken the U.S. Dollar?_3

Similarly, the euphoric tone in stock markets has been a major factor behind the dollar's inability to rally this year. Both euro/dollar and pound/dollar have a strong positive correlation with U.S. stocks, so if there is any correction in equity markets, that might also help the dollar get its mojo back.

Source: XM

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