Dec 3 / Victor Arduin

The Brazilian currency could face an even more challenging environment in 2025

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US jobs data suggests dollar weakness will not be linear

  • After inflation fell significantly throughout 2024, the rate cut by the FOMC in September opened the door to the dollar's weakening and created a more bullish outlook for commodities.
  • However, US nonfarm payroll data suggests that the economy remains strong, raising doubts about the pace of monetary easing in the world's largest economy over the coming months.
  • While some commodities benefit from their own market fundamentals, others, particularly in the agricultural sector, may face corrections in a more uncertain macroeconomic environment.
  • In this scenario, the release of the CPI this week could have a significant impact on the U.S. bond market, which is once again seeing a rise in yields. As a result, the dollar may find support until November, when the Fed’s decision on interest rates takes place.

Introduction

Last month, the US Federal Reserve reduced interest rates by 50 basis points, reflecting growing concerns about the American labor market. Given the Fed's dual mandate, which aims to maintain price stability and support full employment, this move underscores the balancing act between controlling inflation and ensuring robust employment levels.

However, the latest payroll data came in 100,000 jobs above expectations. If, on the one hand, this is good news, as it reduces the chances of a hard landing (a scenario in which the recent restrictive monetary policy could lead the economy into recession), on the other hand, it affects market expectations, which are now predicting a slower pace of interest rate cuts in the current cycle.

Due to the influence of US interest rates on the dollar and, consequently, the impact of the US currency on the commodities market, this report will discuss how the weakening of the dollar will not be linear and may experience fluctuations in the coming months.

Image 1: US – PCE Inflation (%)

Source: Refinitiv

Image 2: US – Unemployment Rate (%)

Source: Refinitiv

Unemployment falls again in the US

After a prolonged period of restrictive monetary policy, inflation in the U.S. economy is converging toward the 2% target throughout 2024. As a result of this improvement, the FOMC (the committee responsible for U.S. interest rate decisions) found room to lower rates in September. In this environment of reduced risk aversion, we've observed a rise in market optimism, with investors showing a greater tendency to allocate funds toward volatile assets such as commodities and equities. Furthermore, the US dollar experienced a significant depreciation, with the DXY index falling below 100 for the first time in 2024.

The robust non-farm payroll result, with the creation of 254,000 new jobs, is generating uncertainty about the magnitude of the next interest rate cut. A heated labor market could exert inflationary pressure in the future, which would put US monetary policy under greater scrutiny. A loss of market credibility would be costly for the Fed, and the institution will take measures to prevent this from happening. In this sense, will be important to guide the next FOMC decision, with the majority expectation in the market currently pointing to a cut of 25 basis points. Meanwhile, the dollar is finding support to gain value again.

Image 3: US – Nonfarm Payroll

Source: Refinitiv

US treasury yields react to possibility of slower rate cuts

Recently, China announced a new stimulus package to strengthen its economy, which is perilously close to deflation and could face difficulties in achieving its growth target of 5%. Although some sectors of the country, such as exports and industrial production, are performing well, the Chinese real estate sector continues to decelerate and poses significant risks to the commodities market, especially for energy products like crude oil.

While in the East, the most significant risk vector for the commodities market comes from China, in the West, signals from the U.S. labor market are also concerning. The effects of American interest rates are still rippling through the economy, which could raise the unemployment rate in the country to nearly 5%. Although the likelihood is low, the risk of a recession cannot be completely dismissed. Additionally, the growth of part-time employment and the decline of full-time positions raise red flags.

In this context, we may gradually observe improvements in the commodities market amid strengthening demand fundamentals from Asia, while macroeconomic data from the U.S. could lead to corrections in the coming months.

Image 4: US – Treasury Yield (%)

Source: Bloomberg

Summary

Part of the optimism observed in September, largely driven by interest rate cuts in the US, is reversing at the start of October due to labor market data suggesting that the next monetary policy easing will be smaller, possibly around 25 basis points.

This could have an impact on the commodities market. While some continue to benefit from their own market fundamentals, such as energy, where key oil benchmarks have risen by over 12%, new macroeconomic data tends to dampen some of the bullish sentiment gained in recent weeks.

This week’s CPI data could have a bullish impact on the U.S. treasury market if they surprise by showing that price dynamics are still heated. If the opposite scenario occurs, meaning an improvement in inflation, we may see a renewed sense of optimism as the Fed would have more room to cut interest rates.
Written by Victor Arduin
victor.arduin@hedgepointglobal.com
Reviewed by Ignacio Espinola
ignacio.espinola@hedgepointglobal.com
www.hedgepointglobal.com

Disclaimer

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