Focus on US employment report after stronger ISM with weaker employment component
ADP likely to show some slowdown, preventing US 10 year yields rising above 3%
JPY making some cross gains as rising yields undermine equities
NOK looks to have potential for significant gains due to huge current account surplus
After the stronger than expected ISM but relatively weak employment reading, focus will turn to the employment report on Friday and the ADP report on Thursday provides some sort of read on this, although the correlation has been so poor of late that markets will not assign too much importance to any ADP outturn. Even so, we expect a bit more consistency with the payroll numbers in May. We expect a 290k increase in May’s ADP estimate for private sector employment growth. This would be slightly stronger than April’s 247k, but confirming some loss of momentum in trend, which in March was still running around 500k per month. The labor market remains tight but initial claims have stated to creep higher, suggesting some loss of what has been very strong momentum is starting to happen. This might take the edge off the rise in yields seen on Wednesday, especially since the rise in the ISM didn’t really negate the underlying softer tone we have seen this year.
The strength of the USD on Wednesday reflected the stronger than expected ISM data, with US 10 year yields rising above 2.9%, but this also triggered a reversal in the initial firm tone seen in equities, and the USD gained ground most against the AUD and the European currencies after the data. The CAD performed well, supported by the BoC rate hike and the hawkish BoC tone, warning that they are potentially prepared to act more forcefully. But as we approach 3% yields in the 10 year, it may need more than a mildly better than expected ISM number to convince the market that the economy is going to be resilient to the combination of Fed tightening and the squeeze on real incomes from higher prices, so we would see some risks of a JPY recovery against the riskier currencies from here, with many JPY crosses having come close to retesting the highs of the year on Thursday.
Even so, as long as the market continues to ignore the real value of currencies and focus on the rise in nominal yields, it’s hard to see much JPY recovery without evidence of significant slowdown from hard data. Surveys have certainly been showing some weakness, but things like consumer confidence largely reflect income, and the big uncertainty is whether the savings accumulated during the pandemic will offset the squeeze on current incomes and allow consumer spending to be sustained, both in North America and in Europe. While this is uncertain we would expect ranges to broadly hold near term.
However, one currency that seems to stand out in terms of value in the current market is the NOK, given the huge benefit to the Norwegian current account from the rise in oil and particularly gas prices in the last year. While the direct impact on the NOK of the current account surplus is offset by the government pension fund and Norges Bank buying foreign currency, there is still likely to be some residual impact on the NOK from such a large rise in the surplus, and EUR/NOK is likely to return below 10 unless we see a renewed sharp weakening in risk sentiment.