In the aftermath of the recent non-farm payrolls (NFP) report and the US Treasury refunding announcement, the desk posits that the current trajectory of US yields will play a pivotal role in currency movements, especially for major pairs like EUR/USD, GBP/USD, and USD/JPY. Per the full note from BofA Global Research, the limited clarity from last week's FOMC meeting coupled with a steepening of the US yield curve underscores the heightened sensitivity of the market to incoming economic data. The NFP report is particularly significant as it influences both Fed communication and the overall US rate outlook, posing potential shifts in these currency pairs as traders adjust their positioning based on labor market signals.
What the desk is arguing
The desk emphasizes that upcoming data releases, particularly related to labor and inflation, will dictate market direction in the wake of the recent FOMC outcomes. The limited guidance from the Fed has created a dynamic environment, where market participants are keenly focused on economic indicators. According to BofA's analysis, the steepening of the US curve is indicative of a broader shift in investor sentiment.
Statistically, the significance of the NFP report cannot be understated, with notable implications for Fed policy adjustments. Market expectations for continued tightening might be challenged based on the payroll data, potentially reshaping currency valuations as seen in recent trading patterns.
Where it sits in our coverage
Our current consensus target for EUR/USD is set at 1.1700 with a range from 1.1200 to 1.2000. Notable targets from other firms include bofa at 1.1700 for Mar26 and anz at 1.1609 for the same tenor. Notably, our view aligns closely with several forecasts in the upper bound of the spread.
How other firms see it
Looking across the board, firms like ubs and deutschebank maintain bullish stances on EUR/USD, with targets around 1.2000 by Mar26. Conversely, firms like bofa and goldman forecast a more cautious approach, suggesting targets that lie below our consensus position.
Given the intertwined nature of the USD/JPY and the BoJ's policy stance, as well as the GBP/USD reaction to the Bank of England's rates, these pairs are essential to monitor in light of the impending data releases. Movement in USD/JPY, particularly, will reflect changes in US yields impacted by the NFP results.
01Elevated sensitivity of FX markets to US NFP and Treasury refunding outcomes.
02Limited clarity from the recent FOMC adds volatility to yield expectations.
03Significant implications for EUR/USD, GBP/USD, and USD/JPY based on economic data.
04Market positioning is heavily influenced by labor market indicators.
Market implications
Watch for the EUR/USD to test resistance levels near 1.1700 amidst upcoming labor market data. A surprise in the NFP results could shift yields and subsequently affect these key currency pairs. Traders should remain vigilant of adjustments in speculative positioning leading into the Fed's next announcements.
Risks to this view
A weaker-than-expected NFP print could undermine the bullish outlook for USD and shift the focus toward easing Fed policies, negatively impacting USD valuations against major currencies. Alternatively, robust labor data might reinforce expectations of a more aggressive Fed stance, exacerbating a stronger USD position.
Hello and welcome to Global Research Unlocked, the interest rate in FX series. This podcast is based on our weekly client conference call where our strategists, along with guests from other parts of Bank of America Global Research, discuss the most topical and pressing questions faced by our market. I'm Mark Cabana, co-head of Global Rate Strategy at B of A Securities.
Today is Friday, August 7th. We just got the monthly U.S. labor report about an hour and a half ago, and we are going to review what we learned and what we think the implications for the Fed and the rates market are. We're also going to cover the Treasury refunding this week and share our views on how what we learned shapes our expectations going forward.
Let's go ahead and let's start with Aditya. Aditya, obviously, we got a bit of a soft labor report today. We got a downside surprise, actually a negative employment print for the month of July, some pretty substantial net payroll revisions for the last couple of months.
We also saw a big drop in average hourly earnings, as well as a decline in participation, yet with all of this, the unemployment rate still ticked it down a tenth. So from your perspective, let's just start with the establishment survey. What drove the downside surprise in the establishment employment data?
Right. Thanks, Mark. Good morning, everyone.
So the downside in establishment employment was driven by two sectors. The first one is local government education workers, so public education workers. And that tends to be quite seasonal, particularly around this time of year.
So they basically go off payrolls over the summer and then they come back on. And depending on the timing of the school year, there can be some fluctuation in those monthly prints. So I would expect some of that 50,000 decline in that sector to get paid back in August or later September.
And the other big drop was leisure and hospitality. Now, this is a little bit more concerning. It's a sector that's been down in three of the last four months and the last two declines have been quite substantial.
So if I had to guess, part of what's going on here is that the increase in gas prices is probably weighing on recreational travel over the summer. If that's true, though, the good news is that assuming oil continues to decline, gas prices will go back down and the sector should see a little bit of a recovery. So those were the two big misses in payrolls.
There was a little bit of upside as well. Construction was stronger than expected at 22,000. This is likely related to the data center build out.
Home and business services continues to recover after a couple of years, honestly, of negative numbers and health care continues to add jobs, although at a slightly slower pace than in the past. I should just add that the private number really wasn't that bad, right? So payrolls were down 23,000, however, private payrolls were up 30,000.
So big impact again from public education workers. But the private number looks pretty close to break even in our view. Great point on the private number.
Great point on some of the more energy and gasoline sensitive parts of the labor market as well. And it is, I agree, somewhat notable that there does appear to be a little bit less concentration in hiring, given the uptick in some of the goods producing and construction sectors that you noted. Now, on the unemployment rate, that obviously went in the opposite direction in terms of implying a stronger labor market, but was accompanied by a notable drop in participation.
How do you make sense of the household survey? So a lot of what you see across the two surveys is symptomatic of a supply shock. What would you get if there is a big contraction in labor supply?
You would get a decline in labor force participation, particularly if it's immigration related. And you have kind of like high propensity participation folks now no longer in the labor force. So you get lower participation, lower employment, and lower unemployment.
And that nets out to a tighter labor market. The Fed has said, and I know we'll get to the Fed in a sec, but if there's one thing that they could look at across all the labor data, it would still be the unemployment rate. And I would note that the unemployment rate is two tenths below where any of them thought it would be by the end of this year.
So that's kind of an interesting development as well. The only thing, honestly, in today's data that doesn't fit the supply story is the decline in wage growth. So that to me was probably the more dovish aspect of today's number than the drop in payrolls.
Great. Now, you had mentioned the Fed. Let me ask you a question related to the data in the Fed in two slightly different ways.
First, if you were advising the Fed on what you think they should take from this data, what would you advise them? And then second, what do you think they will actually take from this data? Okay.
So if I were advising the Fed, I would say, look, you have expressed a view that the labor market is roughly in balance. You have said that breakeven job growth is very close to zero. Given the latter, the former is still true.
We will get a few negative months per year if breakeven job growth is close to zero. It should not shock you. You've also said that the labor market is not a source of inflationary pressures.
And you should feel better about that given the wage numbers. So nothing in your labor story should really change based on what you learned today. Now, what will they take from it?
I think this probably shifts the distribution of rates slightly to the left, right? There's no doubt about that. And that's kind of the way the markets have reacted, right?
So this is a Fed that it's hard to escape the conclusion that this is a Fed that fundamentally leans dovish. And honestly, the markets are saying that, right? I find the market reaction, again, this is another good news, bad news is good news type that market reaction.
And I find this so interesting. With equities up, it's almost like the market is saying, we don't actually think the labor market's that weak. We think things are fine.
But we think the Fed will basically not have the guts to hike, right? So if I were advising the Fed, I would say it's all about inflation for the next few months. But realistically, I think this reduces the odds.
We're not changing our call, but it reduces the odds that they'll hike. And from a rates market perspective, as you know, that is indeed the signal that we're getting. So the rates market has initially bull steepened after the weaker than expected employment data.
You're seeing front end real rates drive the move. So as I speak, I see two-year real rates down about eight basis points, two-year nominals down five. So obviously, the market is thinking that there will be a less tight real path of monetary policy, less tight nominal path of monetary policy as well.
And we have seen that the market has pared back the extent of hikes from the Fed, as I see it right now. The September meeting is priced just about 50-50. We're expecting, or the market is now expecting roughly 30 basis points of total hikes from the Fed by the end of this year, and about 40 bps over the next one year.
So really a bit of a reduction in near-term expectations for the Fed to act, but clearly a market that still is holding on to probability that they will be hiking, and despite the data sees September as about a coin flip. Now for our views, obviously the employment report this morning is a headwind to them. As you know, we've recommended that clients be underweight at the front end and in flatteners.
It's not a good day for that, but we're still going to hold the views until we get more information. We'll obviously get CPI next week, and DPA, you and your team are thinking that we'll see a modestly spicy CPI print, as well as elements that will feed through into a modestly spicy PCE print. So still holding that view, though certainly conviction is a bit lower after the data today.
We are cognizant, Aditya, as you noted, that some of this may be driven by summer seasonals, and if that is indeed the case, then it's possible that we see a little bit of give back from some of the softening that we see in today's print. Now more broadly, Aditya, I wanted to come back to you on some of the things you've been writing recently about the Fed's reaction function and Warsh's communication style. There's been a lot of debate in the last week and a half about if the market's reaction to the July FOMC was overdone, if it's the bond market that's just whining about not being able to live with forward guidance, and if there is still framework guidance that is needed.
I know you were writing about some of these topics in your U.S. Economics Weekly. So you want to share your views with us here?
Yeah, sure. So the way we think about Warsh's communication strategy is the following, right? There is a reasonable case to be made that the Fed could speak less.
Maybe it'll make them a little bit more nimble. Now I think this is all very marginal because historically, even the dot plot, which is an actual written down forecast, has not been a good predictor of Fed policy rate. So how much are they actually constrained by what they say they're going to do?
But maybe at the margin, it could help for them to do a little bit less forward guidance, right? Now forward guidance is fundamentally different from the reaction function. So the other thing I would say on forward guidance is that even if the Fed doesn't speak at all or doesn't do any forward guidance, there is going to be an issue where you're not going to get a clean signal from the markets on their read on the data and the economy.
They're always going to be also pricing in the Fed's response to the data, right? In fact, the original idea of this hall of mirrors between the market and the Fed, which Walsh is very concerned about, was actually proposed by Bernanke before the forward guidance, right? So it's not just a function of forward guidance.
Anyway, the other question, though, is should the Fed tell us their reaction function? And I think, yes, they absolutely should. And he refuses to.
I mean, when he was pressed on this, he said something very vague. He basically said that, look, with the labor market in equilibrium, if I think underlying inflation is hiking, is increasing, then we should hike. And if it's decreasing, we should cut.
But that's not really helpful, right? If you use his referee analogy, that's like a referee saying, if I see someone breaking the rules, I'll call a foul. OK, but, you know, there are a lot of judgment calls here.
And that's what the market needs to know. What do you think underlying inflation is? You know, how much tolerance do you have for over or under shoots?
And you can express all of that without actually giving forward guidance. And I think this is where Walsh really gets himself into a bit of a difficult situation. And honestly, I think he would be better off if he really wants to stick with this communication strategy.
He would probably be better off not speaking at all. That would, of course, run the risk that he loses the bully pulpit and, you know, the rest of the committee starts guiding markets. And certainly that that risk is alive and well right now.
But if he's going to take these, do these very extended press conferences and then try not to answer basically any of the questions he gets, I think he'd get himself into a lot of trouble because he basically just increases the risk of miscommunication. So the PFT article from yesterday clarified a lot of the stuff and suggested that he knows that it's not been ideal so far. But I just don't know how he corrects course unless he either speaks more or decides not to hold press conferences or cuts them short.
Great. Great. Thanks.
Megan, let me bring you in now for some perspective from the rates market on this Fed communication question, the types of inquiries you're getting from the client feedback last week, over the last week, I should say. What's your take? Where what are the questions you're getting?
How do you answer them and how much of an impact do you think this is still having in the U.S. bond market? Yep. Very fair point, Mark.
So I would say the biggest issue that the rates market had with the press conference last week was that Walsh wasn't committing to an action plan when pressed on how he was going to combat the overshoot of inflation that he's like to talk about over the past five years. He didn't specifically say that the Fed was going to hike. And when we think about what the Fed's toolkit is, you know, certainly balance sheet is one mechanism that they have.
But a lot of the work that that you, Mark, on our team and Katie have done on this really suggested the Fed's limited in terms of how much it can shrink balance sheet right now. We'll need to see liquidity reg changes happen first. And even once those are implemented, a lot of the feedback that we get from the bank CIO community tells us that it's going to take them a long time to ultimately implement these changes and that they need to have a lot of conviction that the next administration is not going to reverse those liquidity reg changes.
So there's pretty limited capacity the Fed really has in terms of managing longer term rates through Fed balance sheet. We also know from our own work on this that there is a limited amount of conviction for a given change in supply and demand in the Treasury market for a given change in the amount of supply that the market has to take down, what the overall rates market impact is of that. The Fed's very well familiar with that, too.
They have published a lot of rules of thumb dating back to the QE period, trying to come up with a rough approximation for what that represents. But they just don't have that conviction that they have with their primary tool, which is the Fed funds rate. So we do think that, as Aditi mentioned, there have been steps taken to correct some of this communication mishap.
We had Cook on Wednesday come out and anchor the market on a stall in disinflation, likely requiring a hike in September. We had the FT article just yesterday that reassured the market that worse would deliver on a hike in September if the inflation data comes in hot. So more so giving the market that very needed guidance that the Fed is going to use the measures core to their toolkit, namely the Fed funds rate, to adjust that if the inflation data indeed does warrant it.
So I do believe, Mark, that this has given the market greater assurance that the Fed is looking at looking at its core tools and will take action if the inflation data warrants it. Great, thanks. Yeah.
And along those lines, Aditi and I had a note out this morning titled Vorshen, the long and control what you can. And to me, when the market is asking itself, well, maybe worse just wants long end rates to rise and that can tighten financial conditions. And shouldn't you just use that?
Our pushback is really that that's fine in theory, but in practice, said actually very little direct control over the long end, especially if they don't want to use their balance sheet. And we know work does not want to use the balance sheet to achieve that outcome. So the risk with that strategy is that you're relying on a tool that you can't directly control and that potential tool can get away from you if you're not careful.
So we expect and we also heard this from St. Louis Fed President Mussolini yesterday that the Fed will continue to influence policy by controlling what it can. And that's really the overnight rate, not the long end.
OK, now, Megan, there's a couple of other things I wanted to discuss with you. One is the refunding and two is FX intervention and the impact on the Treasury market. I know you continue to get a lot of questions there.
Let's first go to the refunding. What did you learn this week? And do you think that anything that we learned from the Fed meeting last week was influencing the refunding communications this week?
Yeah, so let's let's let's go there. And coming into the refunding announcement, we were expecting this growing divide between Treasury and Treasury's Borrowing Advisory Committee. We've seen in recent refunding feedback suggest to Treasury that they soften some of the very formal forward guidance language that they have, which is they're going to be maintaining current coupon auction sizes for at least the next several quarters, which is some of the longest forward looking guidance that they've given the market historically.
And TBAC is looking at the financing needs that that that Treasury has coming in 27, coming in fiscal year 28 and telling Treasury, you know, you've got to soften some of that guidance language. You've got to get the market ready for coupon growth. But Treasury seems to be moving actually further in the opposite direction on that.
They did hold that coupon guidance constant, regardless of the fact that that TBAC is, again, still pushing them to to soften that. But even taking this one step further, they have later in their policy statement, this discussion about the direction of these coupon size adjustments. And they've removed the word increases in guiding the market to expect coupon growth over time to changes, which which leaves more of this uncertainty around the directionality of of of supply changes.
We look at this and Treasury looks at this and TBAC looks at the market, looks at it and really sees there being only one direction, which is up in terms of the amount of issuance that that Treasury needs to contend with. So do you think that, Mark, that there was likely some interaction going on between a Treasury that is more sensitive to overall financial conditions, is looking to manage the messaging to the market through that policy statement? But I think it also suggests two things as well.
So one is that Treasury is getting a lot more comfortable thinking about this through the lens of demand. We have very strong demand right now in bills. We see a lot of good inflows coming into money market mutual funds that could accelerate if we do see the Fed indeed hike.
And when we think about, you know, the coupon supply trajectory and the demand there, we have seen changes in that structural demand moving away from the very back end of the curve and much more so focused in the front end and belly of the coupon curve. So Treasury seems to want to be taking steps and move in the direction of being more responsive to demand, which likely argues for this higher bill share, coupled with a lower wham over over time. But, you know, in addition to just being more market sensitive, it's telling us that Treasury is very willing to go the opposite direction of what TBAC is recommending.
We just say, though, Mark, that it was fascinating to me that the spreads market, you know, kind of where you would expect the market to be trading any of this risk, let's say Treasury cuts bond supply, that they that they do more of a twist and issue more in the belly. Swap spreads were virtually unchanged at the back end of the curve on the day. And I think 20 year spreads actually marginally cheaper.
So the market is very much so looking through this tweak in the language change, saying, you know, you can try to cut the market on this in terms of expectations, but we all know exactly the direction in which you have to take supply, which is which is higher. So we would just say that that was the biggest surprise, of course, that that tweak in the forward guidance language change moving away from increases to changes, but the market very much so looking through that. Got it.
So not much by way of refunding news, very small language shift, but market not overweighting that. The other topic that I know you've been getting a lot of questions about this week is related to the yen interventions and the impacts on the Treasury market. Maybe the way I'll phrase the question to you is, first, how do you understand the desired catalyst for the coordinated yen intervention, especially why is the U.S.
Treasury secretary choosing to be involved? And then second, what impact have we seen and what are you watching for any potential impact to the Treasury market as a result of these dollar selling yen buying interventions, at least from the Japanese authorities? Sure, so let's let's take those in turn.
So why why are we seeing best and want to coordinate now more on intervention? And a lot of this question really resonates with the lesson learned that we've seen and a hopeful, hopefully lesson learned between the U.S. market and the JGB market. JGB curve has been, of course, bear seeping over over this period of time where where the BOJ was deemed as as as less credible on inflation, not not getting out in front of inflation to the degree that that the market deemed necessary.
And it feels very similar to some of the risks that we could see the U.S. fall into. Treasury Secretary Besant likely very well understands the mix that we see between bear seeping in the JGB curve, passing through and percolating through to the U.S. Treasury market.
So if Besant wants to aid in the reduction of that pass through, well, one way to help address that is is getting the the curve, the JGB curve under control and helping to send a credible message that they that that the BOJ in conjunction with MOF are going to be taking steps to actually raise front and front end rates and try to try to control the try to try to control the yen. So this intervention, we think, is likely coming on the back of Besant understanding this, understanding the interaction between these two markets, not wanting to see further spillover into the U.S. rates market. But, you know, specifically this FEMA repo facility, which which Mark, you and Katie wrote about earlier this week, allows allows them off to basically pledge securities to the Fed and in return get liquidity for those securities without having to actually sell the Treasury securities.
So it is an alternative way for for for the the intervention to happen, for for them to access U.S. dollar liquidity without needing to sell treasuries as as the reserve assets. So it's an it's an interesting approach, though, what we see in the H4 one data that came out last night is not only did we not see any usage of the FEMA repo facility, but we actually saw the custodial holdings, which are a proxy for foreign official Treasury holdings that sit at the New York Fed up on the week rather rather than rather than lower. So not any clear sign here in the data that that Treasury securities were sold to fund this intervention and not any clearer science so far that that that we're seeing treasuries get pledged in the FEMA repo facility.
Now, why does FX intervention matter? And to the extent, does it really matter for the Treasury market, which I think is is probably the more impactful question here, too. And I've been highlighting this very structural shift that we have in the overall Treasury demand landscape.
Foreign official investors are much larger share of the Treasury market overall. They're around 30 percent of overall Treasury holdings. Ten years ago, that shares fallen to about 10 percent.
When we look at auction stats, foreign investors overall make up about 10 percent or so of the auction allotment that we see. Seventy five to 80 percent of auctions are really domestic investment funds and hedge funds. So there's there's been certainly this very structural change and the buyer base, foreign official investors, just less evident as the as the marginal buyer base for the Treasury market and have been diversifying their their asset mix.
And we see this in some of the other reserve management data away from from dollars and into things like gold and just a broader diversification of other of other currencies. We've also seen when we look at the most recent two FX interventions by by Japan, that rather than seeing the front end of the Treasury spread curve cheapen, we've actually seen it richen over over those episodes. So there's not really marked as this clear link that we see between intervention flows more recently and actually seeing the front of the Treasury curve sell off or even cheapen for that matter on asset swap.
And I think a big driver and reason of that is just that foreign official investors are playing less of this dominant role in absorbing Treasury demand. And the bigger question really is, you know, do do headlines around foreign intervention and FX intervention, dollar selling trigger the broader buyer base? Do they trigger more asset managers to want to sell Treasury securities and involve a larger Treasury reallocation and buyer strike?
We're not seeing that certainly at this moment. But, you know, that to me would be the more notable impact that we could see from from the Treasury market rather than this just being isolated to pure intervention selling. Got it.
So limited impact so far from these interventions we're watching. We don't see it yet, but it's in the context of smaller Treasury share held by foreign official and recent interventions beyond just the last week or so that have not had much direct Treasury market impact. Great.
Well, thank you, Megan. Thank you, Aditya. Thanks for joining us today.
We hope you found this useful and that you'll tune in next week. Bank of America and B of A securities are the marketing names for the global banking businesses and global markets businesses, which includes B of A global research of Bank of America Corporation. Lending derivatives and other commercial banking activities are performed globally by banking affiliates of Bank of America Corporation, including Bank of America and a member FDIC securities trading research, strategic advisory and other investment banking and markets activities are performed globally by affiliates of Bank of America Corporation, including in the United States, B of A Securities Inc., a registered broker dealer and member of FINRA and SIPC and in other jurisdictions by locally registered entities.
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