MUFG’s Derek Halpenny argues that softer US labour data should push markets to reprice Federal Reserve policy, shifting from rate hikes toward a greater risk of cuts. He highlights weaker nonfarm payroll trends, deteriorating sentiment indicators and receding inflation risks. MUFG expects the Fed to stay on hold, with scope for a retracement of the recent US Dollar rally.

Weaker jobs data challenges Fed hikes

"We have stated here recently and in the Foreign Exchange Outlook released on Wednesday that market pricing on Fed policy had become excessive with close to two rates hikes priced by March 2027. The nonfarm payrolls data for June, released yesterday, should be a key catalyst for market pricing reverting to what we believe is a more realistic outcome – pricing a greater risk of a rate cut rather than rate hikes."

"So the nine FOMC members that indicated the need for at least one rate certainly do not have the same justifications for that now. The jobs market is weaker than was implied at the FOMC meeting and as Fed Chair Warsh stated in Sintra this week, the inflation risks have receded over the last four weeks."

"Based on OIS pricing, there is still a 20% probability of a 25bp rate hike at the next FOMC meeting on 29th July and a 60% probability of a hike by September. The rates curve remains over-priced and market participants appear to be placing too much emphasis on Warsh’s comments at his first FOMC press conference."

"A retracement of the post-FOMC US dollar rally certainly looks achievable over the near-term with the dollar overbought and positioning indicating longs were quickly extended. There is nothing next week to turn momentum back in favour of the dollar which means the next big event-day will be 14th July when we get the June CPI data and the semi-annual testimony from Fed Chair Warsh."

(This article was created with the help of an Artificial Intelligence tool and reviewed by an editor.)