Pound Sterling vs. Dollar: Strong US Wage Data Delivers Coup de Grace

A bad week for the Pound against the Dollar got worse after US labour market data showed a strong rise in wages for workers in the world's largest economy.

The US Employment Situation Summary from the Bureau of Labor Statistics painted a mixed, hurricane-disrupted picture of employment dynamics in the world's largest economy.

The report's headline non-farm payroll figure revealed the economy lost 33k jobs in September which was well below the 90k increase the market had expected and well below the 164k growth seen in August, which itself was revised down from 169k.

Despite the poor headline data, the Dollar rose on the news, pushing the Pound-to-Dollar exchange rate lower from a pre-release 1.3087 to close the week at 1.3059. The Euro-to-Dollar exchange rate fell to 1.1693 having been as high as 1.1715 earlier in the day.

The US Dollar's response looks counter-intuitive at first glance.

But, data from the same report also showed the United States unemployment rate fell to 4.2% from 4.4% previously, which the market had not been expecting. The data helps explain the unexpectedly high average hourly earnings data which showed an increased of 0.5% - compared to the 0.3% expected. This is a cyclical high and the fastest year-on-year increase since mid-2009.

The data helped reinforce expectations that the Federal Reserve will raise interest rates again in December with money market pricing such an eventuality at 77% up from 70% one week prior.

The headline non-farm payroll data was completely overshadowed by the wage figures largely because analysts were expecting this months data to be impacted by the disruptions to the economy caused by an especially active hurricane season.

"Hurricanes took a toll on hiring in September, as payrolls registered their first decline since late 2010. The headline number showed a decline of 33k, with broadbased weakness due to Irma and Harvey. The hurricanes did have a particularly strong impact on restaurants and bars in the affected areas, which will see a rebound in the coming months," says Royce Mendes, analyst with CIBC World Markets.

Looking ahead, Mendes reckons the hurricanes' impacts will make it difficult for markets to find a clear message, but the strong wage data should tip the scales towards a stronger Dollar and higher yields.

"US nonfarm payrolls declined in September for the first time in seven years, as the impact of the devastating hurricanes on the labor market was bigger than estimated. But given the rather fast progress in the clean-up efforts, we anticipate to see a corresponding technical rebound in employment gains already over the next one to two months," says Dr. Harm Bandholz, CFA, Chief US Economist at UniCredit Bank in New York.

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Surprise Expected

Damage to the Dollar might also have been limited by the observation that the unexpected was the expected outcome of the data release.

“As Janet Yellen wisely points out, it’s always risky to pay too much attention to noisy data. Nevertheless traders have latched onto today’s NFP release with gusto. The Dollar took off despite a downbeat set of nonfarm employment numbers as wage growth finally picked up," says Neil Wilson, Senior Market Analyst with ETX Capital.

The extreme low reading may not have come as such a surprise to market participants as there was a higher-than-average variation in forecasts this month, due to the impact of Hurricane's Harvey, Irma and Maria which made payrolls difficult to accurately assess.

A "huge" variation in expectations, according to ING Bank's FX Strategist Viraj Patel, suggested a high tolerance of surprise in the result (especially if it is lower due to Hurricane effect) and a low impact on the Dollar, which ended up being an accurate prediction.

"The standard deviation among analysts is 40k (double what it normally is). This suggests that a payrolls surprise may have a subdued impact on markets. While a negative surprise may be chalked down to hurricane effects, and potentially overlooked by markets, we think this may already be in the price of the USD," says Patel.

However, a December rate hike is now a fait accomplis so even a poor result in the data was unlikely to shake the Dollar argued Richard Perry, an analyst with Hantec Markets, in his event preview.

There was a risk of a heavy revision of August's data, which is a commonly highly revised month, however, in the end August was only revised down by 5k from 169k to 164k. 

Perry correctly predicted that a major focus would be wage growth due to the significance attached to this metric as a driver of inflation, which remains surprisingly low considering the otherwise tight labour market.

There was an expectation of +0.3% rise in earnings month-on-month (mom), which would mean that the year-on-year (yoy) number would remain at +2.5% for the third month.

Such a result would indicate that there was, "little real wage pressure still there," says Perr, however, in the end wages rose by a higher-than-anticipated 0.5%. 

"The broader trajectory for the USD, will need to see wage inflation encroaching on 3.0% (yoy) to be convinced that the US economy isn't stuck in ‘lowflation’ mode," he said.

In the end the 0.5% mom result is likely to lead to a yoy gain nearer the 3.0% required to endorse the Fed's current hawkish view. 

Perry noted that other features of the report could also impact on the Dollar, including the 'participation rate' or percentage of the population actively seeking work. If it was trending higher it could boost the greenback: "anything up to 63.0% or above would be dollar positive," said the Hantec analyst.

The Dollar has been in an uptrend - to keep that going it is likely a combo of good payrolls and wages would be required from today's report - in the end just one - good wagers was required to keep the Dollar rising, exceeding expectations.