US Jobless Rate Hits 7%, Time to Load Up on Dollars?

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Daily FX Market Roundup 12-06-13

US Jobless Rate Hits 7%, Time to Load Up on Dollars?
Behind Euro’s Post NFP V Shaped Reversal
CAD: Second Strongest Month for Job Growth Since June
AUD: Construction PMI Hits Highest Since April 2010
NZD: Gold Down 1.5%
GBP: House Prices Tick Higher, Inflation Expectations Rise
Yen Crosses Driven Higher by Risk Rally

US Jobless Rate Hits 7%, Time to Load Up on Dollars?

It is almost hard to believe that less than 6 months ago, Federal Reserve Chairman Ben Bernanke said bond purchases would be reduced this year and stopped completely when the unemployment rate reaches 7%. In September, he back peddled on these comments because the jobless rate was falling too quickly. Today the U.S. unemployment rate hit a 5 year low of 7% and the central bank has not even begun to curtail bond purchases. So if the Fed wants to stick to their plan and pare back most of their Quantitative Easing program by the time the unemployment rate reaches 6.5%, they will need to taper within the next 2 months. Before today’s non-farm payrolls report, we believed that there was only a 15% chance that the Fed would reduce asset purchases before the end of the year but now those odds have soared to 50%. There are strong arguments for being both patient and aggressive which is why this month’s FOMC decision will be close call.

Not only did the unemployment rate drop from 7.3% to 7.0% but more than 200k jobs were created in the month of November. Average hourly earnings increased 0.2% and the labor force participation rate rose 63%. Although the strength of the labor market increases the risk of tapering, stocks rose 1% today as investors started to realize that the Federal Reserve is tapering because the economy is strengthening. Between the sharp rise in consumer confidence in December, upward revision to GDP growth and ongoing improvements in the labor market, a reduction in asset purchases may not do as much damage on the economy as many investors fear. At this stage, March is long too wait and since it is in the central bank’s interest to reduce bond purchases gradually and over a longer period of time, there’s enough positive economic surprises to justify tapering in December.

However many economists are sticking their view that the Fed will not taper until 2014 because of the unevenness in the housing recovery and low inflation. While the participation rate increased, it is still down 0.2% from September’s levels. Labor participation in general is a big problem that could be a new reality for the central bank. The December meeting is also close to holidays and Bernanke may not want to end his term being known as the Scrooge of Christmas.

Regardless of whether the central bank chooses to taper in December, January or March, they will be reducing asset purchases within the next 4 months, and more like within the next 2 months. When they start to wind down the program, it will not be a one-off move but the beginning of a series of reductions that will eventually bring monthly bond buys down to zero. For this reason, we believe that it is time to reload dollar long positions particularly against the Japanese Yen. It should only be matter of time before USD/JPY takes out this year’s high of 103.74 and moves towards 105. The only risk for this outlook is if the Fed decides to lower its unemployment rate threshold from 6.5%, which would imply that they would like to spread their reduction in bond purchases over a longer period of time.

Behind Euro’s Post NFP V Shaped Reversal

There were many questions about the EUR/USD post NFP reversal today and we want to take this opportunity to address them. The stronger than expected U.S. labor market report initially drove the EUR/USD lower which is intuitive because the good number supports the dollar. However within 30 minutes of the release, the currency pair erased all of its earlier losses to end the day higher. Believe it or not, this V shaped reversal in the EUR/USD is not unusual after non-farm payrolls. In fact we are surprised when this move does not occur. The reason why the strong non-farm payrolls report is positive and not negative for EUR/USD is because euro is a risk currency. The initial reaction was to buy dollars but once U.S. equities opened for trading, the EUR/USD followed stocks higher. While the currency pair appears poised for a test of its yearly high of 1.3833 on a technical basis, from a fundamental perspective, the gains should not last. Unlike U.S. data, Eurozone economic reports continue to surprise to the downside with German factory orders falling 2.2% in October. The region’s recovery is extremely uneven and though ECB President Draghi is in no rush to ease monetary policy, positive U.S. data surprises should make the dollar more attractive to investors. Meanwhile EUR/CHF fell sharply today on the back of stronger inflation. For the first time since the SNB introduced its 1.20 EUR/CHF floor, consumer prices increased – a testament to the effectiveness of the central bank’s currency policy.

CAD: Second Strongest Month for Job Growth Since June

The Canadian, Australian and New Zealand dollars extended their gains against the greenback today on the back of improving risk appetite and stronger economic data. While the market’s was focused on the U.S. labor market report job growth in Canada also beat expectations. More than 21,000 jobs were created last month, up from 13k in October. This was the second strongest month for job growth since June but the benefit for the Canadian dollar was limited by the fact nearly all of the job growth was in part time labor. So while it may be encouraging to see improvements in Canada’s labor market, part time jobs are never as good as full time jobs. The unemployment rate remained at a 5 year low of 6.9% while the labor force participation rate remained at its lowest level in more than a decade. For the Bank of Canada, labor market conditions were not strong enough for a rate cut to be considered and certainly not weak enough to fuel speculation for easing. In Australia, construction sector activity grew at its fastest pace in April 2010. Despite the drag from the mining sector, housing market activity has not lost much momentum.

GBP: House Prices Tick Higher, Inflation Expectations Rise

Of the other major currencies, the smallest move today was in sterling. The British pound ended the North American trading session unchanged against the greenback and slightly lower against the euro. The front of the week was busy for the currency but in the back of the week, the market’s focus was on the EUR and USD. Only 2 pieces of second tier data was released from the U.K. overnight. According to Halifax, house prices rose 1.1% in November. The housing market has been shining star of the U.K. economy and the government’s focus on providing support to lenders has gone a long way in promoting the recovery. With the Help to Buy Scheme accelerated to Q4, we expect further momentum in the sector. Inflationary pressures are also expected to rise in the next 12 months according to a survey conducted by the Bank of England. This is not a major surprise considering that the economy in general is expected to continue to recover in the coming year.

Yen Crosses Driven Higher by Risk Rally

Thanks to the sharp rally in U.S. equities, the Japanese Yen traded lower against all of the major currencies. The biggest gains were seen in CHF/JPY and NZD/JPY but all of the Yen crosses traded higher by more than 1%. Led by the rise in USD/JPY, EUR/JPY cleared 140 to hit a high of 141.06 intraday while CHF/JPY broke above 115. When Asia opens for trading on Sunday, investors will most likely bid the Nikkei higher, which should drive the Yen even lower. No major economic reports were released from Japan but the head of the Government’s Pension Investment Fund in Japan said he expects to reduce the funds exposure to domestic bonds as soon as possible. This announcement is important because the GPIF is the world’s largest investment fund and if they choose to dump Japanese bonds, their funds will have to be invested elsewhere. According to the Chairman of the fund’s advisory group, they have agreed to seek higher returns, which could mean more investments in domestic stocks and foreign bonds.

Kathy Lien
Managing Director

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