Behind the Jobs Day Dollar Reversal
Daily FX Market Roundup 09.02.16
Investors were left scratching their heads after the U.S. dollar rose to a fresh one-month high against the Japanese Yen on the back of non-farm payrolls. The jobs report missed expectations with payrolls rising only 151K, wage growth slowing to 0.1% and the unemployment rate holding steady at 4.9% in the month of August. From all angles this report should have taken the dollar lower but instead it ended Friday with broad based gains. Looking at these numbers the Federal Reserve has a flimsy case for tightening in September and a hike in December remains in doubt but the rise in the dollar reflects more complex thinking.
Taking a look at the Fed Fund futures contracts, the market is now pricing in a marginally lower chance of a rate hike in September (32% vs. 34% from Thursday) and December (59% vs. 59.8), showing that expectations for a rate hike this year did not change much after the payrolls report. U.S. stocks moved higher, which is consistent with no immediate tightening but Treasury yields rose, which is the primary explanation for the dollar’s reversal. Even though USD/JPY rose from 102 to 104 over the past week, most investors never believed that the Fed would raise rates in September and today’s jobs number doesn’t alter their views. When Janet Yellen speaks later this month she will say that December is still on the table because there are 3 jobs reports before that meeting so its too early to draw any conclusions and close out their options. Investors could be thinking that by taking away the immediate pressure to raise rates in September, today’s jobs number gives the Fed the leeway to maintain a hawkish bias and maybe even harden the case as 3 more months of low rates gives the economy additional time improve. In the coming week, the Federal Reserve’s Beige Book report is scheduled for release along with non-manufacturing ISM. While the dollar should lose upside momentum, the abundance of key events elsewhere in the world means that it won’t be just about the dollar next week. If the European Central Bank, Reserve Bank of Australia and Bank of Canada are dovish, those currencies could fall, driving the dollar higher.
Speaking of rate decisions, the European Central Bank’s monetary policy announcement is the most important event risk on the calendar next week. While no immediate changes in monetary policy is expected, ECB President Draghi is expected to remind investors that inflation is low, the economy is weak and easier monetary policy may be needed. Consumer spending has been particularly soft, manufacturing and trade activity took a hit after Brexit and most importantly, inflation remains well below target with year over year core CPI growth slipping to 0.8% from 0.9% in August. Aside from the decision on rates and Draghi’s press conference, the central bank will also release its economic projections and if changes are made, they will likely be euro negative given the deterioration in manufacturing and inflation data over the past week. Like many of the major currency pairs, EUR/USD went on a rollercoaster ride post NFPs but the currency pair ended the week below the 100-day moving average which puts it on track for a move down to 1.1125. On a fundamental and technical basis, the euro should trade lower but the crosses could experience greater losses on a percentage basis than EUR/USD.
The U.K. economy and the U.K. currency proved to be extremely resilient this past week. The biggest surprise was the manufacturing PMI report which rose to its strongest level since October 2015. The decline of the currency post Brexit played an important role in supporting export activity and helping the economy weather post Brexit uncertainty. In addition to new orders, consumer goods also saw healthy demand with consumption improving since Britons decided to leave the European Union in June. Cable shorts have been squeezed mercilessly as a result because most investors were positioned for economic Armageddon. While Prime Minister May said they don’t see a need to consult Parliament on Article 50, her opposition to “Leave” suggests that they will opt for the mildest form of Brexit possible, satisfying only the minimum of requests made by voters. The U.K. won’t remain in this state of “uncertain bliss” forever but there will be a period of calm before Article 50 is invoked. Looking ahead, the U.K. PMI Services, industrial production and trade balance reports are scheduled for release. We are optimistic especially after last week’s healthy PMI manufacturing report and rise in the GfK consumer confidence index.
Neither the Reserve Bank of Australia nor the Bank of Canada expected to change monetary policy next week, which means the focus will be on guidance. The latest economic reports from Australia were terrible with manufacturing activity contracting and retail sales stagnating. However since the RBA met in August, we’ve actually seen just as much improvement as deterioration in Australia’s economy. Manufacturing and trade activity improved and most importantly iron ore prices have found a bottom. So a signal to ease is not a done deal. AUD/USD ended the week pretty much where it started and for the time being we’re are slightly more bearish than bullish and expect another test of 75 cents in the coming week. Aside from the RBA, Chinese trade numbers will also have a big impact on AUD. With no major New Zealand economic reports on the calendar outside of the Global Dairy Trade auction, NZD will most likely take its cue from AUD. New Zealand data was mostly softer with building permits plunging in the month of July and business confidence falling. However the RBNZ is in no rush to ease again and for that reason NZD outperformed most major currencies – a trend that could continue in the coming week.
Next week is a big week for Canada. Aside from the Bank of Canada’s monetary policy announcement, IVEY PMI and August labor market numbers are also scheduled for release. CAD has been taking its cue from oil and that did not change on Friday when the loonie soared as oil jumped 2.5%. In the coming week though, Canadian fundamentals will play a bigger role and unfortunately consumer spending, labor market conditions, housing market and price pressures weakened since their last meeting so chances are the central bank will be dovish and could even talk about the need for more easing. If USD/CAD drops down to 1.29, it could be an attractive level to establish a short CAD position pre-BoC.