US economic growth and Fed move to drive global market sentiment

Market expectations are tied now, closer than ever, to the Fed in anticipation of a potential rate increase and this will be the predominant theme in the future.

All eyes are on the key drivers of the US dollar this month. Michael Probst / AP Photo

Currency and commodity markets were hit hard last month, reversing gains made in June.

No currencies were spared against the United States dollar. The euro and British pound respectively notched up losses of 1.47 per cent and 0.58 per cent. The Australian dollar was hit the hardest, dropping 3.14 per cent.

Along with the loss of trillions of dollars from the sharp sell-off in Chinese equities in recent weeks, the faltering commodity markets have also weighed down the Aussie, which has fallen past six-year lows against the dollar. Gold finished 6.58 per cent down on the month, closing at more than five-year lows below a key psychological support at US$1,100 an ounce. Perhaps the biggest loser was the West Texas Intermediate crude oil contract which tanked 20.65 per cent to close below $47 a barrel.

With so much event-driven risk shaping markets over the past few weeks – namely the much expected conclusion of the Greek bailout programme and the rout in Chinese bourses – the biggest and main driver of market sentiment remains the US growth story and the interest-rate expectations tied to US economic data.

Market expectations are tied now, closer than ever, to the Fed in anticipation of a potential rate increase and this will be the dominant theme in the future. From the onset, expectations were for a first US rate rise in seven years to take place in September.

But with inconsistent signs of growth in industrial output, housing and, most importantly, jobs this year, expectations of a rate rise are shifting to the first or second quarter of 2016.

The Federal Open Market Committee’s announcement last week, its shortest statement yet, showed that the Fed saw improvements in the labour market, with job gains “solid” and the risks to the economy and employment outlook “nearly balanced”. With regards to a rate increase, the Fed had to see “some further” improvement in the jobs market. It was a rather dovish statement that leads us to believe that the first rate rise will follow next year.

With no distractions from Greece for the next few months and with the worst of the Chinese sell-off likely to be behind us, global market sentiment will be dictated by the US economic scenario, starting with this Friday’s non-farm payrolls report. Expect to show new job additions of 240,000, with the jobless rate expected to remain unchanged at 5.3 per cent.

Although we largely expect little variance in these numbers, we will closely watch for revisions of the previous month’s figures and, perhaps more crucially, the condition of the US labour participation rate and how it affects the overall unemployment rate.

The June report showed the unemployment rate falling from 5.5 per cent to 5.3 per cent. However, this was because of a shrinking US labour force.

In June, the participation rate shrunk from 62.9 per cent to 62.6 per cent, the lowest since the mid-1970s, which means more than 400,000 people left the workforce.

The rate at which new jobs are being added is not sustaining the monthly losses to the US labour force and this equalisation will be the key to the Fed pulling the trigger on its first rate rise in a long time. The Fed would need to see consistent gains in the headline number (230,000 to 250,000 at the bare minimum), with the jobless rate dropping to 5 per cent amid a stable or growing labour force participation rate. Some members of the Fed suggest that the shrinking US labour force could be a result of demographic changes, including baby boomers going into retirement. However, when compared with other G7 nations which share the same demographics, the US is the only country that has a shrinking labour force among them.

Along with the US jobs report, we will keep a close eye on the other key drivers of the dollar this month, including industrial production (previously 0.3 per cent), inflation (previously 1.8 per cent) and the US GDP (previously 2.3 per cent).

We maintain our strong dollar bullish sentiment for the month ahead and expect to see further improvement in these core US economic drivers.

Gaurav Kashyap is a foreign-exchange expert based in Dubai.

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