Dollar Hits Skids after Payrolls Miss Spot and China Retaliates against Latest "Trade War" Tariffs

-USD slides as payrolls miss expectations and "trade war" escalates.

-Payrolls disappoint, ISM index slides, augering fears of Q3 slowdown. 

-China retaliates against latest White House tariffs, escalating "trade war".

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The Dollar reversed course and slid lower Friday after official data showed US jobs growth surprising on the downside during July while momentum in the services sector slowed, and as China retaliated against the latest salvo in President Donald Trump's "trade war".  

The US economy created 157,000 new jobs during July which, down from an upwardly-revised 248,000 back in June, was beneath the consensus forecast of 191,000 and marks the slowest pace of job creation since March. 

Nonetheless, this helped push the unemployment rate back down to 3.9%, from 4% in June, which is close to the post-crisis low of 3.8% seen back in May.

Meanwhile, average hourly earnings rose at a month-on-month pace of 0.3% in July, in line with expectations, keeping the annualised pace of wage growth steady at 2.7%. 

"After a barn-burner quarter for growth, payrolls weren't able to continue that momentum into Q3. Nevertheless, while a 157K gain in non-farm payrolls was well below the 193K expected for July, an upward revision of almost 60k to the prior two months leaves the level of employment roughly where the consensus had forecast," says Royce Mendes, an economist at CIBC Capital Markets. 

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.

"With the gain in the preceding two months revised up by a cumulative 60,000, the labour market still appears to be in good health. This won’t derail the Fed’s plans to hike interest rates again next month," says Paul Ashworth, chief US economist at Capital Economics. 

The US Dollar index was quoted 0.09% lower higher at 95.08 following the release Friday after reversing an earlier 0.04% gain. The Pound-to-Dollar rate was 0.12% higher at 1.3024 and the Euro-to-Dollar rate was 0.18% higher at 1.1604.

"The swing in payroll growth from 248K in June to 157K in July looks more like noise than signal, but we can't be absolutely sure, given the clear dip in the ISM non-manufacturing employment index in recent months," says Ian Shepherdson, chief US economist at Pantheon Macroeconomics. "Other employment indicators, like JOLTS and the NFIB survey, remain very strong, though, so for now we're happy to stick to the idea that the trend remains 200K-plus."

Friday's price action comes amid an escalating "trade war" between the US and China that had kept the world's reserve currency supported until the noon session Friday.

It is not clear whether the reversal in the US Dollar was a result of the labour market data, or China having retaliated against President Donald Trump's latest trade measures at the same time as the data were out on Friday.

"Early indications for the third quarter suggest that growth has cooled off somewhat, but the data are still providing evidence of healthy underlying momentum," says CIBC's Mendes. "Some cooling in growth was always expected after Q2's torrid pace, so these decent but unspectacular readings for July won't materially change expectations for the economy moving forward."

Separately, and following the payrolls data, the ISM Non-manufacturing index fell further than was expected for the month of July, adding further to early signs US economic growth moderated at touch at the beginning of the third quarter. 

"One soft month proves nothing, and most of the commentary from respondents cited in the press release is very positive, though some cited uncertainty over tariffs. Behind the headline, though, the employment index rebounded after three straight weak readings," says Pantheon's Shepherdson.

The ISM Non-manufacturing index, which measures activity in the US services industry, fell from 59.1 to 55.7 for the recent month when markets had looked for a more modest decline to 58.6. The Institute for Supply Management says much of the decline was the result of a fall in the current activity part of the index.

"The sharp fall in the ISM non-manufacturing index in July adds to evidence that growth is weakening from the stellar pace recorded in the second quarter, but we doubt that will prevent the Fed pressing ahead and raising rates again in September," says Michael Pearce, another economist at Capital Economics, in a note Friday.

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Federal Reserve to Lift Dollar?

"The US dollar has continued to strengthen against Asian currencies overnight," says Lee Hardman, a currency analyst at MUFG. "The situation could be made worse today if the release of the NFP report reveals more compelling evidence of strengthening wage growth. So far it has at least been reassuring that the Fed plans to stick to only gradual rate hike despite stronger economic growth."

The Federal Reserve has raised interest rates seven times since the end of 2015, taking the Federal Funds rate range to between 1.75% and 2%. Analysts say the top end of that range will reach 3.25% around the end of 2019, with the next increases seen in September and December 2018.

Hardman says keeping a lid on inflation is key to preventing the Federal Reserve from stepping up the pace of its interest rate rises, although containing inflation requires wage growth for American workers to be subdued.

If wages were to show signs of a sustained rise, markets would likely price in a sharper increase in interest rates for the quarters ahead, lighting a fire beneath the US Dollar. 

Already, America's greenback has converted a 4% 2018 loss into a 2.78% profit during the four months since early April, following a sustained rally that drew a line beneath a prior 12-month period of heavy losses. 

Most analysts agree that superior levels of US economic growth have bolstered the case for Federal Reserve rate hikes at a time when the interest rate outlook elsewhere in the world has deteriorated, incentivising traders to sell other developed world currencies and buy US Dollars.

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.

"Trade War" Lifts USD but Threatens Global Economy

Interest rate considerations have not been the only source of upward pressure on the Dollar of late, as the so called "trade war" between the US and China has stoked fears for the global economic outlook and boosted demand for the world's reserve currency.

"The renminbi is still weakening at a rapid pace against the US dollar at an annualized rate of just over 40% since the middle of June as it hit another fresh low overnight. Negative market sentiment towards the renminbi was reinforced overnight by comments from US Commerce Secretary Wilbur Ross, who warned that the US will keep turning up the pressure on China for as long as it refuses to level the economic playing field," Hardman writes in a breifing Friday.

President Trump has instructed US trade representatives to increase the tariffs it levies on around $200 billion of Chinese exports, from 10% to 25%, citing China's failure to address US concerns over "unfair trading practices" that include "forced technology transfer and intellectual property theft". China responded by imposing retaliatory tariffs on around $60 billion of US products Friday. 

Once the latest tariffs have been introduced the White House will have imposed levies on more than $250 billion of Chinese exports to the US, although it has threatened to target the full $500 billion of goods that China exports to America each year. Fears are that a tariff fight between the world's largest economies will dent economic growth the world over.

This week's tariff move came after talks to avoid an escalation of the trade conflict fizzled out in June and also follows hard on the heels of a 7% fall in the value of the Renmimbi relative to the US Dollar. Many in the market say the Renmimbi fall has the People's Bank of China written all over it, given a fall in exchange rates could neutralise the US tariffs by making Chinese goods cheaper for overseas customers to buy.

"Since mid-June, the renminbi has depreciated by about 7% against the US dollar, with market volatility surging. It is easy to assume that the move was at least supported by the PBoC, as for many years China was criticised for artificially weakening its currency to support the domestic export sector," says Esther Reichelt, an analyst at Commerzbank.

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