Fed-speak eased traders’ concerns this morning. December’s payroll report was a blockbuster, sparking a risk rally. Commodity currencies strengthened on the jump in the Bloomberg Commodity Index (“BCOM”), the cut by China of the required reserve ratio by one percentage point, and the US equity rally. Ahead, watch AUD/USD and USD/JPY during US-China trade talks next week.

This Morning’s Minefield

Part 1: Fed’s Mester
I woke up this morning looking forward to payroll Friday. The first thing I saw was CNBC grilling Cleveland Fed President Loretta Mester about the latest Fed rate hike and the market’s negative reaction to it. When asked if the Fed Fund Rate was at neutral, she replied “that’s precisely to me what data dependency means. We’re now going to have the economy assess incoming information. It’s going to tell us.” She asked if she had to decide on interest rates today, would she raise rates? Mester had a great answer, which was important for markets – she stated that she doesn’t have to decide on interest rates today. Furthermore, “I want to take the time that I have to actually evaluate how the economy is going,” Mester said – shortly before the payroll report was released.

Part 2: Payroll report
Traders were on edge ahead of the December payroll release, which ended up being a very strong result. Payrolls rose 312k vs the Bloomberg consensus estimate of 184k. Average hourly earnings rose 3.2% yoy and the participation rate increased. The USD strengthened as a knee-jerk reaction, but then lost ground to G10 currencies except the Yen on the back of a risk rally, which was helped by Fed Chairmen Powell’s comments.

Part 3: Fed Chairman Powell
Powell pacified the markets this morning on the back of the strong December employment report. He spoke at the annual meeting of the American Economic Association in Atlanta this morning. Powell said that he’s “listening sensitively to the message that markets are sending” about downside risks to growth and that “With the muted inflation readings that we’ve seen, we will be patient as we watch to see how the economy evolves.” If needed, Powell said the Fed would change balance sheet run off policy. This eased traders’ concerns that the Fed was not paying enough attention to market signals, and added fuel to the equity market rally.

Putting it all together
US economic fundamentals are stronger than what the market has been pricing. The latest employment read was strong and while the December manufacturing ISM was lower than expected, it was impacted by negative news on tariffs which had been frontloaded. Fed-speak today was pragmatic and reassuring to the market, emphasizing that there was no pre-set course on interest rates.

Commodity currencies have rallied across the board, helped by the 1% move up in the Bloomberg Commodity Index (BCOM). One of the FX market’s largest positions was short AUD/USD, which has reversed with an almost 3 sigma move higher. AUD/USD broke resistance at 0.7050 (chart). USD/JPY is almost back to its pre- flashcrash levels (chart).

Continue to watch these two USD pairs into and during US-China trade talks next week. The Australian Dollar is sensitive to China news and the Yen is, of course, a safe-haven currency which has strengthened in reaction to negative US-China trade headlines.

Chart: AUDUSD breaks higher    (source: Bloomberg)

Chart: USDJPY — almost back to pre-flashcrash levels (source: Bloomberg)