EMFX Rides the Green Wave: Impact of Fed's Shifting Tone on Currency Positions

FX Daily: EMFX surfs in a sea of green

It seems investors are starting to think that the Fed is done with rate hikes and are now starting to reduce underweight positions in risk assets, including emerging market currencies. This is dollar negative. Today's US jobs data will be a key determinate of whether this week's new trend has legs or will be quashed by strong hiring or wage numbers.

 

USD: Will NFP can feed into the Fed pause narrative?

European investors face a sea of green as they survey global equity markets this morning. Decent 1-2% rallies in global equity benchmarks have been seen right through Europe, the US and Asia. Underpinning that move undoubtedly has been the drop in US rates, where investors are shifting away from the higher-for-longer Fed narrative which dominated in September and October. They now seem to be exploring the Fed pause/Fed peak story. For reference, pricing of 1m OIS USD rates in two years' time rose from just above 3% in June to a peak of 4.75% last month and has since dropped back to 4.17%.

The move in rates has surely seen investors scale back some paid USD rates/long dollar positions and prompted an unwind of some favourite short currency positions in the EM and commodity space. That is why we think the Australian dollar is doing so well and we continue to see upside for a relative value trade in the region, long AUD/CNH. We also note with interest a big drop in USD/KRW overnight. The Korean won typically has a high beta on global equities (but not an attractive yield) and its sharp rally is a good barometer for the mood in the market. With Korean FX reserves falling for a third month in a row it seems Korean FX authorities have been supplying the market with FX liquidity, as have the likes of China and India – presumably along with Japan shortly too. We think the drop in USD/KRW helps define a broadly risk-on, soft dollar environment today.

Whether this environment has further to run will be determined by today's October US jobs data. Despite the ridiculous inverse correlation with ADP (which might point to a +350k NFP number today) consensus is around +170/180k. Investors will also want to see whether last month's +336k figure gets revised lower. Consensus also sees a 0.3% month-on-month average earnings figure, but that should still bring the year-on-year down to 4.0%, the lowest since June 2021.

Assuming no upside surprises today, we favour the dollar handing back a little further of its gains, especially against the high yielders (e.g., Mexico and Hungary) given the renewed interest in the carry trade.  DXY could drop to the 105.50/55 area today as long as the US jobs data is not too strong.