NFP,BullardandDollarSmile

The OPEC plus meeting about which we had written yesterday didn’t come out with any definitive declaration on Thursday as there were still some internal differences which remained to be ironed out between the members. However, the indications were that the release of supply will be lower than the market expectations. The meeting members are still deliberating on the exact contours of the same. Risk of a demand crash on the back of a virus variant remains their key concern. Prospect of a US Iran deal getting that supply in the market will also figure into the calculation. Brent Crude prices though touched their highest since October 2018 in the trade yesterday trading at 76.70 $/ bbl.

In the other news the market keenly awaits the NFP data due today. The Dollar has strengthened in the anticipation of a good number. Dollar index is trading at 92.5 which is around its highest since the start of April. The expectations around NFP is that there are close to 700k jobs which have been added to the economy in the month of June. The unemployment rate is also slated to fall from 5.8% to 5.7%. The key consensus which the markets are arriving at is that better numbers indicate Fed’s policy course correction will start. Hints of which will come in the next policy meeting. Various Fed speakers have started preparing the ground for the same. Yesterday president of the St Louis Fed James Bullard said that the US economy is in much better shape now to what was forecasted in December last year, in fact it is “roaring back”, expected to show better growth than China. Also, there is the need to be attentive towards inflation concerns and the bottlenecks.

We have written it multiple times in the past that one of the key roles of the central bankers and policy makers is to manage the expectations. Markets don’t love surprises as it increases volatility. As we heard Kaplan’s comments yesterday and Bullard’s today, flagging inflation as a key concern is part of preparing the ground. Slowly some parts of the market will reconfigure their bets and become more open towards a taper or an eventual hike discussion. Strength in USD against its peers is part of that reconfiguration.

Trader and Author Brent Donnelly introduces us to a concept peculiar to the US Dollar in his book The Art of Currency Trading. He writes about the concept of Dollar Smile. It theorizes that the USD appreciates when the US economy is doing very well or very poorly, and the USD depreciates when the US economy is in between. Essentially buy USD when the US is booming or in recession and sell Dollars otherwise. The US recession represents a risk off and safe haven buying whereas US bumper growth results in unwinding of carry trades and hence again the selling of HY EM assets back to the Dollar. If you chart USD performance against US growth the curve would look like a smile. Hence the US smile. The above discussion again emphasizes the fact that the global trade is denominated in USD. The scenario doesn’t look like changing in the near term and hence we all would do well to clue into US data releases.