Dollar Retreats from Highs against Euro and Pound Following Jobs Report

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The Dollar pared some of its recent advances after data showed U.S. wage growth was softer than expected in December and job creation continues a downward trend.

The non-farm payrolls (NFP) report for December showed 223K jobs were added which was down from November's 256K.

The figure was nevertheless above consensus expectations for 200k, providing an upside surprise that would typically be a knee-jerk positive for the Dollar which has rallied this week amidst a series of other labour market indicators that point to a still-strong economy.

Indeed, the unemployment rate unexpectedly fell to 3.5% from 3.6% in November, defying expectations for a reading of 3.7%.

The NFP report was however not strong enough to break a now well-entrenched trend of declining monthly increases in job gains and the Federal Reserve will therefore likely stick with existing plans to hike rates a couple more times before halting.

Above: The trend is one of slowing job creation. Image courtesy of DailyFx.

"Payrolls can’t keep up this pace," says Ian Shepherdson, Chief Economist at Pantheon Macroeconomics. "The third straight hefty drop in temp hiring, down 35K, is an ominous sign, as it often leads other hiring."

Viraj Patel, a strategist at Vanda Research, says this was a Goldilocks jobs report, "strong job gains, more job supply (uptick in participation). Doesn't change the Fed trajectory here - softer wages gives them time to take hikes slowly".

Average hourly earnings rose 4.6% in the year to December, which was far lower than the 5% the market was looking for and represents a deceleration from November's 4.8%.

The wage figures are important in that they will tell the Fed that fears of an inflationary wage-price spiral are now unlikely to be realised.

"There are signs that wage growth could now be on a downward trend. This is good news for the Fed, which will likely slow the pace of rate hikes to 25bp in early February," says Knut A. Magnussen, an analyst at DNB Bank ASA.

The mixed nature of the data is matched by a pullback from recent highs in the Dollar.

The Pound to Dollar exchange rate (GBP/USD) has come back under notable pressure this week as it cracked below 1.20 and bottomed on Friday at 1.18417 amidst a Dollar rebound.

Above: GBP/USD at 15-minute intervals, zooming in on the NFP reaction. Consider setting a free FX rate alert here to better time your payment requirements.

Following the wage figures it is back at 1.1920, taking typical bank transfer rates to around 1.1678, cash and holiday rates at competitive providers to around 1.1809 and rates at competitive transfer providers to around 1.1880.

The Euro to Dollar exchange rate has also retreated from recent highs in early 2023, falling to a low of 1.0482 on Friday. It has since pared losses back to 1.0540.

Expectations for the future of Federal Reserve interest rates policy are key to explaining currency market movements and the Dollar weakened through the final weeks of 2022 as the market prepared itself for an end to rate hikes early in 2023.

"This report will not stop the Fed raising rates by 50 basis points in February. But a further 50bp increase in March makes little sense, in our view, if wage growth continues to soften, especially if payrolls slow too; remember that two further employment reports will be released before the FOMC meeting," says Shepherdson.

The U.S. currency rebounded this week from oversold conditions created by a break-neck sell-off in the latter part of 2023, but the gains were also aided by a series of labour market statistics that suggested the Fed might have to push interest rates somewhat higher than previously expected.

The NFP data will nevertheless provide the decisive verdict on labour market trends and the outcome from the January 06 report is that there is little reason to deviate from previous expectations regarding Fed policy: the jobs market is slowing.

The Dollar might have returned to strength early in 2023, but the bigger picture remains one in which the Fed steps back in the first quarter and the Dollar eventually retreats on a more sustained basis.

"The USD cycle is being stretched. We expect to see a bumpy road, but position for a stronger depreciation in 2023," says Monica Defend, Head of Amundi Institute. "Kind Dollar is losing some of its shine".

“We believe the global backdrop has shifted and valuations are now appealing enough to look to buy both currencies against the greenback, whose upward momentum has run out of steam” - Paul Mackel, Global Head of FX Research at HSBC.

HSBC are buyers of GBP and EUR against USD in 2023.