Will Non-Farm Payrolls Drive USDJPY to 105?

Daily FX Market Roundup 10.06.16

Investors put more money into U.S. dollars today ahead of Friday’s non-farm payrolls report. This strong demand for the greenback took USD/JPY above 104, EUR/USD below 1.1150 and GBP/USD to its weakest level in more than 3 decades. There’s been no stronger trend than the one in USD/JPY as today marks the seventh straight days of gains for the pair and the 8th day without a pullback. The last time there was this many positive days for USD/JPY was in March 2011 and at the time the pair did not peak until 10-days later. There are sound fundamental reasons behind USD/JPY’s move but given its speed and velocity we think there’s a strong chance for a post news reversal. It may not happen on Friday but it could certainly occur on Monday when U.S. markets are closed for a holiday. But the question that we posed today is whether non-farm payrolls could drive USD/JPY to 105 and if the jobs report is strong enough it is certainly possible.

The Federal Reserve made it very clear that how quickly they raise interest rates hinges on how fast the labor market improves. They are looking for job growth to accelerate, wages to rise and unemployment to either hold steady or improve. Last month’s non-farm payrolls report was extremely disappointing as job and wage growth slowed. While some investors believed this was a one-month blip and some U.S. policymakers agree like the ones who voted for a rate hike this month, Yellen was far more cautious.

Thankfully the bar isn’t that high this month. Economists are looking for only a modest increase in jobs (172k vs. 151k) and no change in the unemployment rate. Based on eight leading indicators for non-farm payrolls we follow each month, there’s an overwhelming case for a solid jobs report (see list below). The highlights include jobless claims which are at their lowest levels since the 1970s, continuing claims which are at its highest since 2000. The employment component of non-manufacturing ISM rose to its strongest level since October 2015 and consumer confidence is at a 9 year high. The only argument in favor of a weaker jobs report is ADP and that’s not saying much.

Considering that nearly everyone at the Fed believes the case for a rate hike has strengthened, unless fewer than 150K jobs were created last month and earnings growth misses expectations, September non-farm payrolls will support the case for a December rate hike.
Yet unless non-farm payrolls exceed 250K and average hourly earnings growth reaches 0.3% or better, policymakers and investors should be skeptical about the momentum continuing. After tomorrow’s report there are 2 more non-farm payroll reports scheduled for release so there’s no reason to rush into conclusions that a rate hike at the end of the year is a done deal. For this reason we believe traders should be aware that USD/JPY could experience the classic buy the rumor sell the news after an initial pop that could take the pair as high as 105.

Here’s a Look at the Arguments For/Against a Strong Jobs Report

Arguments in Favor of Stronger Payrolls

1. Employment Component of Non-Manufacturing ISM Rises to Highest Level Since Oct 2015

2. Employment Component of Manufacturing ISM Rises to 49.7 from 48.3

3. 4-Week Average Jobless Claims Drops to 253K from 263K (Almost Lowest Since 1973)

4. Continuing Claims Drop to 2.05M, Lowest Since 2000

5. Consumer Confidence Index Hits 9 Year High

6. University of Michigan Consumer Sentiment Index Rises to 3 Month Highs

7. Challenger Reports -24.7% Drop in Layoffs vs. -21.8% the previous

Improvement in Weather Brings Back 50k Jobs

Report Shows 6% Increase in Withholding Tax

Arguments in Favor of Weaker Payrolls

1. ADP Employment Change Drops to 154K from 175K

If the U.S. jobs report is good, we could see sterling make a run for 1.25. The currency pair dropped to a fresh 31 year low, shrugging of all of the improvements that we have seen in U.K. data. There’s no doubt that GBP/USD is becoming oversold and moving on momentum alone because the 2 year U.S. – U.K. yield spread actually moved in favor of GBP/USD today with U.K. yields rising more than U.S. yields. We also heard from Bank of England Governor Carney who said monetary policy has been overburdened. While he certainly wants PM May’s government to pick the slack, the challenges they face with political and economic uncertainty leaves the door open to further easing. U.K. industrial production and trade balance are due Friday. Sterling’s weakness and the improvement in manufacturing activity points to a stronger number but with NFPs on tap, investors will continue to shrug off U.K. data.

Meanwhile EUR/USD dropped to 1.1150 on the back of U.S. dollar strength and ECB member Constacio’s confirmation that reports on ECB taper is not correct. Mixed data also did not help. German factory orders beat estimates with an increase of 1.0% vs. 0.3% expected for the month of August. German construction PMI also rose but Retail PMI for both Germany and the Eurozone saw declines compared to the previous period. German Retail PMI dropped to 53 vs. 54.1 prior. Eurozone retail PMI was reported to be 49.6 vs. 51 – these are signs of weaker consumer spending. Germany is slated to report industrial production data tomorrow but like GBP, how EUR trades will be determined exclusively by the market’s reaction to NFP.

The focus will also be on the Canadian dollar tomorrow with Canada’s employment and IVEY PMI reports scheduled for release. After last month’s strong rise in jobs (particularly full time), a retracement is expected in September. Manufacturing activity however should receive a lift from the weaker currency. For the fifth time in the past month USD/CAD is testing the 200-day SMA. If tomorrow’s U.S. jobs report is strong and Canada’s jobs report is weak, the pair will blow past this resistance level easily. All three commodity currencies experienced losses today with the largest loser being AUD. These moves were driven mainly by the strength of the US dollar, with pressure on Aussie exacerbated by profit taking in AUDNZD. Data was actually better than expected for most countries. Australia reported a smaller than expected trade balance deficit, coming in at -2010m vs. -2300m expected. Canada reported better than expected construction data, with building permits soaring 10.4%, eclipsing the estimated increase of 1.0% Even an increase in oil prices could not lift the falling Canadian Dollar as crude prices rose past $50 today. There were no economic reports from New Zealand.

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