The Trade Week Ahead – Nothing Is Linear

Friday’s non-farm payrolls (NFP) are getting everyone a little bit complacent – the slight misses in the employment change and average hourly earnings has the some suggesting inflation won’t materialise in the US as fast or as strong as expected.

That missed the whole theory of markets and economics – ‘Nothing is Linear’ in intra-timeframes, even intra-month or intra-quarter are not straight lines, and that is clearly the case in US employment.

Here are a few charts on US employment to look at that might take your interest:

Here is the US average hourly earnings on a longer term trend

(Source: Bloomberg)

And here is the long-term trend of ‘underemployment’ in the US

7.8% underemployment – the RBA would kill for that, considering Australia’s employment slack sits at over 13% and is showing next-to-no signs of shifting lower.

Why this is important is that this level of full employment has one outcome – higher wages leading to higher consumption which leads to higher inflation.

The Fed’s ‘gradual increases’ to the Federal funds rate I believe will move to ‘moderate increases’ to the Federal Funds rate pretty soon suggesting there is still a further 3 rate rises in 2018 rather than the forecasted 2 remaining.

September is the month economists forecast could be the ‘no change’ meeting if the Fed is to give the Federal funds rate a break – that means there will be 4 more NFP’s ad 4 more reads on inflation.

If the Fed really is happy for an overshoot in inflation then so be it, however it won’t be happy with an overshoot that turns into a tidal wave of inflation which I see is building considering the strength in the US economy.

What this has meant in the markets is we have seen a return of DXY – The US basket is back and with a vengeance.

The turn-around here is long overdue and using the same words I used earlier nothing is linear, and the expected increase in the USD will falter time and again but the central case for direction is pretty clear – rates are rising and may rise fast. This should take the USD with it.

Last week I highlighted this chart from Westpac off Bloomberg showing the 2-year up trend in the AUDUSD breaking down.

What I didn’t anticipate was the speed it would breakdown and then retract. The trade balance on Thursday was enormous locking in a record surplus and locked in three months of A$1 billion surplus for the first time in over ten years – net exports are clearly positive for Australian GDP. However, the medium term view on the AUD is still embedded in the chart above.

The carry trade will widen further over the year current spread of -20 basis points in the Aussie-US ten year is only the beginning if a further 75 basis points comes into effect from the Fed. I still see a 73c handle in the pair in the coming months.

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