USD: US economy contracts ahead of nonfarm payrolls report – MUFG

The US dollar has continued to rebound ahead of tomorrow’s nonfarm payrolls report for April. It has resulted in the dollar index rising back above the 100.00-level overnight although US dollar gains are mainly against the yen. The release of the latest nonfarm payrolls report tomorrow will be scrutinized closely to assess the initial negative impact on the US labour market from President Trump’s 'Liberation Day' tariffs announcement, MUFG's FX analyst Lee Hardman reports.

Dollar Index back above 100.00 as Yen weakens further

"Trade policy disruption alongside heightened policy uncertainty at the start of President Trump’s second term is expected to make businesses become more cautious over hiring new employees in the near-term and has raised fears that they could go further and cut back if the US economy slows sharply in response to the negative trade shock. The release of the ADP survey was consistent with slowing employment growth estimating that private payrolls increased by just 62k in April."

"The US economy was already being impacted by changes in US trade policy even before tariffs were implemented. The GDP report for Q1 revealed that the US economy contracted marginally in Q1 by an annualized rate of -0.3%. It was the first quarterly contraction since Q1 2022. The biggest drag on growth in Q1 was net trade as imports surged ahead of the tariff hikes and businesses built up inventories providing some offset to the hit to growth. Net trade subtracted an outsized -4.83ppts from growth in Q1 while inventories added 2.25ppts. At the same time, household consumption slowed in Q1 adding 1.21ppts to growth following on from robust growth recorded  during the 2H of last year when the average quarterly contribution was 2.59ppts."

"While some slowdown in household consumption following robust growth in 2H 2024 was always likely, the sharp plunge in consumer confidence measures in recent months driven by inflation fears and angst over job security have since made it more likely that weaker growth will continue. Those concerns over much weaker growth are more than offsetting the near-term upside risks to inflation from tariff hikes when market participants weigh up the implications for Fed policy. The US rate market has moved to price in over 100bps of Fed rate cuts by the end of this year with the next cut expected by June or July. The upside surprise for the core PCE price index for Q1 coming in at 3.5% did not deter building Fed rate cut expectations. A much weaker nonfarm payrolls report tomorrow poses the main downside risk for the US dollar‘s recent tentative rebound."