USD vs NFP: Labour market remains tight but inflation pressures ease
By Neil Dennis
14:33, 6 January 2023
US Dollar Index
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The number of jobs created in the US during December was higher than expected data showed on Friday, weighing on the dollar as investors figured the Federal Reserve could further ease the pace of interest rate increases.
The dollar index (DXY), a weighted measure of the dollar's strength based on its performance against a basket of rival currencies fell from 105.63 to 104.93, after non-farm payrolls increased by 223,000 during December.
Market analysts had expected closer to 200,000, but following data on Thursday from ADP, the US's largest payrolls provider, that showed 235,000 new jobs were created in December, the official non-farm payrolls number came as less of a surprise.
Furthermore, data on Wednesday showed that job openings in the US remained at robust levels.
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Inflationary pressures ease
The Federal Reserve, which has toned down its hawkish rhetoric in recent months in response to cooling inflation, pays close scrutiny to employment data as part of its dual mandate to achieve price stability and maximum employment.
At its final Open Market Committee meeting of 2022, the Fed raised interest rates by 0.5% following four-successive 0.75% hikes.
Analysts believe that this week's employment data will justify the Fed continuing to hike at this lower pace, as expectations of an economic slowdown are likely to weaken the jobs market in the coming months.
Andrew Hunter, senior US economist at Capital Economics, pointed to "signs of weakness" under the headline jobs growth figure.
"Cyclical sectors like manufacturing saw a sharper slowdown, retail employment rebounded only modestly after months of declines, and professional and business services employment fell again," he said.
This was underlined this week by ISM purchasing manager data that showed activity in the manufacturing sector contracted for the second-straight month in December as Americans shifted spending away from goods to services.
Friday's data also showed the pace of average hourly earnings eased to 4.6% in December from 4.8% in the previous month. The rate had been expected to rise to 5%.
Hunter added: "The softer gain in average hourly earnings suggests wage growth is slowing, and we still think the labour market will weaken more markedly this year as the economy slips into recession, helping to reinforce the downward trend in core inflation already underway."
How might the Fed react?
With the Fed funds rate now standing at 4.25%-4.5% the Fed might consider slowing the pace of hikes further. The Fed's own median forecast for the terminal rate is 5.1%.
That would mean only 75 basis points of hikes left to be added - possibly one more 0.5% hike at its next meeting on 31 January and a final 0.25% raise on 22 March. This would take the main rate to 5%-5.25%.
All will depend, however, on the data. Headline inflation peaked at 9.1% in June and has since eased back to 7.1%, thanks largely to falls in energy prices. Core inflation has stayed a little more sticky. The next CPI reading is on Thursday, 12 January.