Non-Farm Payrolls, China and State of Currencies
Daily FX Market Roundup 01.07.16
China’s shortest trading day turned into a long session of pain for currencies and equities. There’s been no let up in the selling this week with the U.S. dollar and Japanese Yen climbing to fresh highs against the British pound, Japanese Yen, Swiss Franc, Canadian, Australian and New Zealand dollars. At this stage Non-Farm Payrolls need to rise by 300K or more to turn sentiment around and unfortunately economists are only calling for a weaker number. However anything short of 300K may just lead to a dead cat bounce in USD/JPY, risk currencies and equities because expectations for a Fed March rate hike has been hit by the volatility in the financial markets. Before New Years, the market was pricing in 52% chance of tightening in the first quarter but those expectations have now fallen to 39%.
Investors shouldn’t expect non-farm payrolls to save the market. While it is the most important piece of U.S. data on the calendar and the center point of Fed policy, economists are looking for a relatively benign number. The chance of job growth exceeding 300K is extremely slim. Some of the other indicators for the labor market shown below point to a good reading but even if payrolls beat by 50K, it won’t be enough to change the market’s minds about the odds of further Fed tightening in this type of market environment. It probably won’t change the Fed’s minds either because there are 2 more NFP reports before the March meeting. For us, average hourly earnings will be the main focus of the labor market report. If wages rise then there’s some hope but if they slow, then expect equities and USD/JPY will bleed more losses.
Arguments for Improvement in Non-Farm Payrolls
1. Rise in Employment Component of ISM Non-Manufacturing
2. ADP Employment Change Rises to 5 Year High
3. Sharp Rise Consumer Confidence Index
4. Continuing Claims decline slightly
5. Challenger Job Cuts Fall by 27.6%
Arguments for Deterioration in Non-Farm Payrolls
1. 4 Week Average Jobless Claims Rises to 275K from 270K
2. Drop in Employment Component of Manufacturing
3. Small Drop University of Michigan Index
Meanwhile it is important to understand what is going on in the Chinese Yuan. We’ve seen significant weakness in the currency since the IMF decided to include the Yuan in its SDR basket. With that big hurdle cleared China returned to its policy of keeping the Yuan weak because the economy was slowing faster than they anticipated. Yuan depreciation is a policy tool and the intervention that we saw overnight is a familiar tactic that also used in August after they devalued the currency by 2%. They ordered state run banks to buy the Yuan to drive out speculators. In terms of motivation, China is weakening the Yuan for a number of reasons – growth is slowing and currency weakness is consistent with monetary easing. They are also losing market share to neighboring countries and this is an attempt to help Chinese firms become more competitive. Of course this leads to a variety of consequences, the most significant of which is an intensification of the currency war. Other emerging market nations will be forced to respond with their own actions. It will also lead to more outflows and reduce the odds of more near term tightening by the Fed.
Oil prices continue to fall, dropping as low as $32.10 a barrel intraday. This combined with the sharp contraction in manufacturing activity drove USD/CAD to a fresh 12 year high. The IVEY PMI index slipped to 49.9, the lowest level since April. Looking beneath the hood however the deterioration was driven entirely by inventories as employment, supplier delivery and prices increased. Although this makes the report less discouraging, as long as oil prices continue to fall, the path of least resistance for the loonie will be lower. The 1.4190 is the first level of resistance followed by the 2000 swing low of 1.4290.
AUD/USD traded below 70 cents intraday while NZD/USD extended its losses. Tonight will be another busy one for Australia with retail sales and construction PMI scheduled for release. China’s troubles have hit the country hard and the currency is paying the price. The New Zealand dollar followed lower but its losses were modest in comparison.
Euro remains the most resilient of the bunch and one of the few major currencies to rise against the dollar and Yen. It rose 1% intraday to hit a high of 1.0909. Many investors may be surprised by the strength of the currency but money is flowing out of China and back into Europe. Euro has also been a funding currency of choice in recent months and the market meltdown has investors unwinding those positions. Eurozone data also continues to beat with Retail PMI and Confidence improving. The unemployment rate dropped to 10.5% from 10.6%, offsetting the larger decline in Eurozone retail sales in November. The upswing in the December retail PMI figures also offset the more dated retail sales report.
Finally Sterling fell to a fresh 5 year low versus the US. dollar despite higher house prices according Halifax but like the euro its losses were nominal because money is flowing back from China. UK trade numbers are scheduled for release tomorrow and given the drop in manufacturing activity, the trade deficit is likely to have widened in the month of November.