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The dollar pushed a little higher on Friday following further tightening in the US labour market in March, but the monthly employment data suggested wage growth may be peaking, which could damp the enthusiasm of dollar bulls in the coming months.
Monthly non-farm payrolls grew by 431,000 – a little shy of the 450,000 expected – but upward revisions to previous months more than accounted for the shortfall. Meanwhile, the unemployment rate eased to 3.6% from 3.8% in the previous month, and the labour force participation rate edged up to 62.4% from 62.3%.
The dollar reacted by turning around earlier losses, leaving the Dollar Index up 0.3% at 98.64. The euro dipped 0.2% to $1.1041 and the pound eased 0.3% to $1.3091. The Japanese yen was the biggest faller among the majors, down 1.1% at JPY122.96.
Wage growth slowing?
Average hourly earnings rose by 0.4% month on month in March, up from 0.1% in February, while earnings on an annualised basis rose 5.6% from 5.2%.
The monthly wage rises over the past two months looked soft, analysts said, perhaps suggesting that second round inflationary effects are yet to materialise as Americans’ pay packets struggle to keep pace with consumer price inflation.
Ian Shepherdson, chief economist at Pantheon Macroeconomics, said: “One soft print out of the blue is easy to dismiss as noise, but two is harder to ignore – three would be definitive, so the April number is now hugely important. Without sustained rapid wage growth an inflation spike can’t become a spiral.”
Michael Pearce, senior US economist at Capital Economics, agreed: “There are tentative signs that wage growth has peaked.”
Pearce added: “That in turn should feed through to weaker underlying inflation, easing pressure on the Fed to deliver a series of aggressive rate hikes.”
Dollar strength faces headwinds
This has significant implications for the dollar, which has been riding high on inflation and interest rate expectations over the past 10 months while also gaining safe haven traction since the start of the Russia/Ukraine conflict.
Wage growth appears to be slowing as the Federal Reserve embarks on what is expected to be its biggest cycle of interest rate hikes since the series of moves that started in 2015 following the end of the financial crisis.
Markets are already pricing in six or seven rate hikes from the Fed this year, which would take the Fed funds rate up to around 2.5%. So, if wage growth continues to lag consumer price rises, the Fed’s strategy, as the central bank suggests, could begin to bring inflation back towards its target of 2% in the medium term.
The dollar would likely lose some support under such conditions, particularly if current market pricing is wrong and the Fed is able to cut short its rate-hike cycle as inflation cools.
The US currency will also lose momentum if the Fed moves too aggressively and slowing wage growth, combined with persistently high inflation, hits consumer activity.
Dollar haven: Russia/Ukraine effect
But markets are full of uncertainties and the biggest of these currently is the Russia/Ukraine conflict, which has sent markets into turmoil over the past six weeks, with fears of a growing energy crisis causing oil and gas prices to soar.
However, the latest US Purchasing Managers’ Index survey, also published on Friday by S&P Global, showed that US manufacturers remained upbeat, despite the effects of the conflict. Moreover, cost pressures appeared to be easing in spite of rising energy prices.
“It was especially encouraging to see business optimism about the year ahead improve further in March, despite the new uncertainties, sanctions and geopolitical risks caused by the Ukraine invasion, with optimism among producers now the brightest since late-2020,” said Chris Williamson, chief business economist at S&P Global.
The medium-term outlook for the dollar remains clouded as peace talk hopes rise and fade, and as the success of the Fed’s policy response to inflation hangs in the balance.
If the Fed’s strategy succeeds and a peaceful end to the conflict emerges, further strong upward momentum for the greenback is likely to ebb. But a continuation of hostilities will provide the dollar haven support.
Meanwhile, as central banks around the world begin to tighten policy in response to commodity-driven inflation, the dollar loses some of its yield advantage.
But Jonathan Petersen, markets economist at Capital Economics, believes the dollar will remain supported, albeit at a slower pace.
Petersen said: “The case for monetary policy divergence to push the dollar higher has arguably diminished over the past month as central banks, notably those in Europe, have prioritised the war’s effect on inflation rather than activity. Nevertheless, we still think that the greenback will grind higher amid a backdrop of slowing global growth, falling commodity prices, and tightening financial conditions.”
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