U.S. Dollar Soars as Investors Raise Odds of December Fed Rate Hike to 70%

The U.S. Dollar finished the week sharply higher after the U.S. Non-Farm Payrolls report blew away estimates, forcing investors to change the probability of a December interest rate hike by the U.S. Federal Reserve from 50% to 70%.

The U.S. Non-Farm Payrolls report for October showed the addition of 271,000 jobs, soundly beating estimates of about 179,000. The unemployment rate ticked lower to 5 percent, marking full-employment. Average hourly earnings increased 9 cents or 0.4%, for an annualized increase of 2.5 percent. This put it slightly above the Fed’s mandated inflation target of 2.0 percent.

The stronger-than-expected jobs report drove up U.S. Treasury yields, triggering steep breaks in the December Treasury Bonds and December Treasury Notes markets. Both futures contracts reached their lowest levels since late August. The 2-Year Cash market yield reached a high of 0.958 percent, its highest level since May 2010.

Higher yields made the U.S. Dollar a more attractive investment, forcing foreign currency markets sharply lower across the board. Sellers also hit the precious metals markets on the news with December Comex Gold futures dropping over $50.00 for the week.

In addition to the strong U.S. jobs data, other factors contributed to the weakness in some of the major currency markets.

The Euro was under pressure last week after ECB President Mario Draghi reiterated in a speech that the central bank was poised to make more interest rate cuts and implement other forms of monetary policy easing, including expanding and extending its current 1.1 trillion Euro stimulus program.

Sellers also hit the GBP/USD after the Bank of England dampened expectations of an interest rate hike in February or March of 2016. The central bank left its benchmark interest rate at 0.50% while issuing a dovish statement that suggested interest rates weren’t likely to move higher until late 2016.

The BoE also predicted near-zero inflation would pick up only slowly even if borrowing costs stay on hold throughout 2016. The central bank’s minutes showed only one Monetary Policy Committee member, Ian McCafferty, voted to raise rates this month, while the other eight members voted to continue to leave interest rates at a historical low.

A more favorable interest rate differential and divergences between central bank monetary policies help the U.S. Dollar gain considerably against the Australian Dollar and the New Zealand Dollar.

The AUD/USD strengthened early in the week after the Reserve Bank decided to keep its policy rate unchanged at 2% despite falling inflation rates.

At mid-week, however, the rally ran out of steam after central bank Governor Glen Stevens said an accommodative monetary policy is likely to be appropriate.  “Were a change in monetary policy be required in the near term, it would almost certainly be an easing, not a tightening”, Stevens said.

Traders interpreted Stevens’ speech to mean the RBA is likely to cut interest rates two times within the next year. Traders are pricing in a 25 percent chance of a rate cut in December, rising to a more than 60 percent chance in February.

The interest rate differential was the primary driver of the weakness by the NZD/USD last week as well as a divergence between the monetary policies of the Reserve Bank and the Fed.

Front-end New Zealand bond yields fell after the release of weaker than expected NZ jobs data, hinting at expanded stimulus expansion bets. U.S. Treasury bond yields rose, however, as investors increased bets for an earlier than expected Fed rate hike. This created a favorable interest rate spread, driving investors into the U.S. Dollar.

New Zealand Dollar traders, however, now believe in a 50 percent probability of a 25 bps rate cut at the next RBNZ policy meeting.