Will this week's non-farm payroll trigger a new round of dollar selling?

As the release of non-farm employment data approaches this Thursday, the market is closely watching the direction of the US dollar, particularly whether the non-farm data will trigger a strengthening of the euro and other non-US currencies.

According to news from the Chase Trading Desk, Citigroup's global foreign exchange strategy team released a research report on the 27th, stating that the asymmetry in non-farm data still exists, meaning that the dollar will decline more sharply when the data is below expectations than it will rise when the data is better than expected.

Citigroup economists predict that the unemployment rate will rise to 4.4%, with only 85,000 new jobs added. If this comes to pass, it could trigger widespread selling of the dollar, with the yen, Swiss franc, and euro likely to lead the gains.

However, for investors seeking the euro to rise above the 1.20 mark against the dollar, this single non-farm data release may not be sufficient. Citigroup believes that due to the market's high expectations for the Federal Reserve to cut interest rates in July, leveraged funds have already shorted the dollar in advance, and profit-taking before the US National Day holiday may limit the sustainability of any knee-jerk decline in the dollar.

Only if the unemployment rate rises to around 5% by the end of the year could this trigger a new round of dovish re-evaluation of Federal Reserve expectations and push the euro against the dollar to reach or even exceed the 1.20 target. Additionally, as hedging costs decrease (i.e., due to Federal Reserve rate cuts), a new round of adjustments in foreign exchange hedging ratios may also boost the euro.

Citigroup remains bearish on the dollar: July rate cut probability still low, limiting the subsequent momentum of dollar declines

In the report, Citigroup reiterated its core view: in the current market environment, the dollar faces ongoing asymmetric risks. In a macro context where the US economy continues to underperform globally while the global economy enters a "soft landing," a historically unfavorable trading mechanism for the dollar typically forms. Therefore, Citigroup's overall strategy is "to short the dollar on rallies."

The upcoming non-farm employment report is likely to continue this theme. The specific predictions from Citigroup's economic team are:

• Unemployment Rate: Jumping from the previous value of 4.2% to 4.4% (higher than the market median expectation of 4.3%).
• Non-farm Employment Growth: Slowing from the previous value of 139,000 to 85,000 (lower than the market median expectation of 110,000).

The report notes that given the recent dovish comments from Federal Reserve officials, even if the employment data performs well, the market's room for re-pricing hawkish expectations from the Federal Reserve is quite limited. Conversely, investor sentiment is generally bearish on the dollar, looking for reasons to sell.

If the data comes true: the dollar faces short-term pressure, and the yen and Swiss franc may become the biggest winners

If the non-farm data is as weak as Citigroup predicts, the market's pricing for the Federal Reserve to cut rates at the July Federal Open Market Committee meeting will further heat up. Current market pricing reflects a rate cut of about 6 basis points in July, and a weak report could push that pricing closer to 12.5 basis points, indicating a 50% probability of a rate cut. In this context, the report expects the euro, yen, and Swiss franc to perform best among G10 currencies. Citigroup also cited historical data as evidence: the last time the unemployment rate similarly jumped by 0.2% (which occurred in the July non-farm report released on August 2, 2024), the yen and Swiss franc saw cumulative gains against the dollar of an astonishing 1.5% and 1.3% respectively within six hours of the data release, although the euro's reaction was relatively mild at that time.

Euro/USD Struggles to Break 1.20 in the Short Term, Needs More Catalysts

Although Citigroup remains bullish on the euro/USD, it believes that the current non-farm data alone is insufficient to push the exchange rate to the 1.20 target. The report lists several key constraints:

1. High Threshold for July Rate Cut: Federal Reserve Chairman Jerome Powell reiterated concerns about tariff-driven inflation in August. This means that it will be difficult for the Fed to take action at the July meeting before seeing the August CPI data (to be released on September 11).
2. Market Position Limitations: Leveraged funds have already increased their short positions in the dollar ahead of the non-farm data release. This "front-running" behavior may lead to a weakening of actual selling momentum in the market after the data is released, limiting the downside potential for the dollar.
3. Holiday Factors: With the July 4th Independence Day holiday approaching, traders may choose to take profits, making it difficult for the dollar's decline to continue.
4. Return of Interest Rate Differential Impact: Although the impact of interest rate differentials on the dollar has weakened this year, this correlation has recently returned. However, since the market has fully digested the Fed's "soft landing" rate cut cycle, unless subsequent data confirms a more significant slowdown in the U.S. economy, the interest rate differential is unlikely to provide sustained upward momentum for the euro/USD.

Medium to Long Term Still Bullish on Euro, Key Support at 1.15-1.16

Looking ahead, Citigroup believes that for the euro/USD to stabilize above 1.20, the market needs to see more concrete signals, such as the U.S. unemployment rate moving towards its forecast of 5% by the end of the year, or a new round of adjustments in the forex hedging ratio due to declining hedging costs (i.e., Fed rate cuts).

For traders, Citigroup's advice is to continue looking for opportunities to sell on dollar rebounds. Specifically for euro/USD, the report believes that the 1.15 to 1.16 range is a strong support level, as this range encompasses the upward trend line, the 21-day moving average, and the highs from April and early June. If the market pulls back to this range, it would be an ideal time to establish long positions.

However, Citigroup also cautions that the dollar's rebound may be very weak, and the depth of the euro's pullback against the dollar may only reach the lows of the 1.16 range at most.