EUR/USD and the Outlook for US Data

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Daily FX Market Roundup 01-10-14

**Out for the Next Week – No Daily Reports until Monday Jan 20

Weak Payrolls is a Major Setback for Dollar
EUR/USD and the Outlook for US Data
GBP: More Signs of Year End Weakness
CAD: Hit By Massive Job Loss
AUD: Jumps 1% on Rally in Gold
NZD: Shrugs Off Weaker Chinese Trade
JPY: Nikkei Resumes Slide Taking USD/JPY Down With It

EUR/USD and the Outlook for US Data

Thanks to the weak non-farm payrolls report, the euro traded sharply higher against the U.S. dollar today, erasing all of the past week’s losses. There’s not much in the way of Eurozone data next week which means EUR/USD will trade primarily on the market’s appetite for dollars. With U.S. retail sales, inflation, manufacturing and confidence reports scheduled for release, it should be another busy week for the greenback. If consumer spending slows as much as economists expect (they are looking for a 0.1% rise in December versus 0.7% in November), the dollar could extend its losses, driving EUR/USD above 1.3750. However it is important to remember that when the Fed reduces asset purchases again, the ECB’s dovish bias will come back into focus. The main takeaway from this week’s European Central Bank meeting is that low inflation and the volatility in money market rates are becoming a bigger headache for the central bank. Mario Draghi strengthened the ECB’s forward guidance and in turn hardened their commitment to easy monetary policy which should be bearish for the euro. Meanwhile the Swiss Franc rallied despite the steep rise in the unemployment rate and decline in consumer prices. Low inflation makes it impossible for the SNB to change the 1.20 EUR/CHF peg this year. In December consumer prices grew at an annualized rate of 0.1%. While this represents a significant improvement from the -0.6% rate in April, it is far shy of the central bank’s 2% target. With no room to cut interest rates, the SNB’s FX policy is one of the few ways to drive up prices. In order for the SNB to consider dropping the EUR/CHF peg, CPI needs to be closer to 1.5% and ideally 2% but in 2014, it is estimated by SECO to gain only 0.3%. At the same time, the central bank can’t raise the peg to encourage a faster increase in inflation because credit is tight and the housing market is growing too quickly – this leaves 1.20 in place for the next year.

Weak Payrolls is a Major Setback for Dollar

The U.S. dollar traded sharply lower against all of the major currencies on the back of the shockingly weak non-farm payrolls report. December was the worst month for payrolls since January 2011 with NFPs rising a mere 74k, which is significantly lower than the 241k increase in November and the 197k forecast.

If not for the drop in the unemployment rate, USD/JPY would probably be trading below 104 and the EUR/USD above 1.37. To the complete confusion of market participants, the unemployment rate dropped to 6.7%, the lowest level in 5 years. Investors should not be misled by the decline in the jobless rate because it is a function of a drop in the labor force participation. In other words, the unemployment rate is only falling because more people are dropping out of the work force. The decline in average hourly earnings and weekly hours confirms that Americans are working less and making less which only happens when businesses are less optimistic. While some of this could be related to the weather according to the BLS, there’s no sugar coating the fact that the pool of available workers shrank by more than 750k over the past 2 months. Yet one month doesn’t make a trend and with the BLS saying that the weather affected 273k people who could not get to work, the most for any December since 1977, there’s scope for a big bounce in January especially since the U-6 unemployment rate remained unchanged at 13.1%.

The big question now is whether weak payrolls will slow the pace of Fed tapering or better yet, encourage policymakers to leave asset purchases unchanged this month. Based on the sell-off in the dollar, drop in U.S. yields and recovery in stocks, investors believe that the central bank will be less aggressive with winding down QE in the first half the year. The Federal Reserve also needs to think hard about their unemployment rate threshold because it could be reached by Janet Yellen’s first meeting as Fed Chair in March and unfortunately the unemployment rate is not falling because the labor market is improving. Even if today’s data is distorted by weather, weak payrolls growth highlights the ongoing challenges of high unemployment in the U.S. economy. According to yesterday’s FOMC minutes, the Federal Reserve has not committed to any predetermined course for reducing asset purchases and today’s weak payrolls number is a good reason for the central bank to take a break from tapering this month and wait for the next NFP report in February before cutting bond buys again. When the central bank meets this month, they will go out of their way to emphasize that rates will not be increased until the jobless rate drops well below 6.5% and to drum this point in harder, they could even lower the target to 6% but that may be a decision taken only after Yellen becomes Fed Chair.

Today’s non-farm payrolls report is a major setback for the dollar. While we still believe the greenback will trade higher this year, it could struggle to find buyers between now and the next time the Fed tapers. This means that 105 could be the near term top for USD/JPY and 1.3550 could be a near term bottom for EUR/USD. However don’t expect a significant sell-off in the dollar because many investors are still looking for a big bounce in January.

GBP: More Signs of Year End Weakness

Of all the major currencies, the British pound experienced the smallest gains against the U.S. dollar because sterling battled with its own disappointing economic reports. The lack of desire to own sterling today is best seen through the selloff in GBP/JPY and rally in EUR/GBP. Industrial production was the latest report showing the U.K. economy slowing towards end of the year. Both industrial and manufacturing production stagnated in November and based on the PMI reports likely declined in December. While we continue to believe that this pullback is temporary and an adjustment after a frothy summer and fall, there is still a number of economic reports from December that will remind investors about the tough conditions at year end. This includes next week’s U.K. retail sales and inflation reports, which pose a downside risk to currency. If any of these reports surprise to the downside, the currency pair most vulnerable is GBP/JPY. A combination of dollar and sterling weakness could drive the pair below 170 which would then open the door to a stronger move down to 165. Based on the decline in shop prices, consumer confidence and BRC retail sales monitor, there’s good reason to believe that spending growth slowed in the month of December.

CAD: Hit By Massive Job Loss

While the financial community was focused on the U.S. non-farm payrolls report, Canada’s jobs number was even worse than the U.S. release. At the end of last year, Canada lost more than 49k jobs and if we exclude the increase in part time workers it was the third worst month for full time employment since 2009 with full time jobs falling 60k. To put this decline into perspective, it would be equivalent of 600k job loss in the U.S.. This surprise deterioration in labor market conditions drove the unemployment rate up to 7.2% from 6.9%. The steady participation rate confirms that these are fresh job losses. Between the deterioration in trade, contraction in manufacturing activity and decline in job growth, the Bank of Canada will have to think hard about reopening the door to easing. They will want to see if this drop reflects month to month noise and the impact of weather conditions but if job growth does not recover next month, they may be forced into action. Today’s report is clearly negative for the Canadian dollar and while we expect the currency to sell off further against the greenback, the biggest losses should be against the euro. Meanwhile the Australian dollar was the day’s best performing currency thanks to the 1.5% rise in gold and decline in the U.S. dollar. The Aussie took the weaker Chinese trade numbers in stride and while employment numbers are scheduled for release next week, we could see a further short squeeze before the release. If AUD/USD breaks above 90 cents, we could see a rapid acceleration towards 91. However a move beyond that level would require a strong jobs number which is challenge considering that the employment component of manufacturing, service and construction sector PMI declined. The New Zealand dollar also performed well but with no data on the calendar, its rally is purely a function of dollar weakness.

JPY: Nikkei Resumes Slide Taking USD/JPY Down With It

USD/JPY dropped below 104 after the disappointing U.S. non-farm payrolls report and this weakness drove all of the Yen crosses lower with the exception of AUD/JPY, which was supported by the strong rally in the AUD. According to the latest economic reports, Japan’s economy continues to recover with the leading index rising to its strongest level since 2007 and the coincident index rising to its strongest since 2008. These measures of economic activity paint a picture of improving health for Japan’s economy one that we think will remain a dominant story throughout the first quarter. Japanese investors ignored the deterioration in Chinese trade activity choosing instead to focus on improvements domestically. The Nikkei stabilized overnight, shrugging off a negative impact from the smaller increase in exports due in part to the sharp rise in imports. China is Japan’s most important trading partner and the rise in imports suggests that even though Chinese growth is slowing, their appetite for Japanese brands have not taken a major hit. Japan’s appetite for foreign bonds on the other hand declined with investors selling 448 billion worth of foreign bonds in the week ending January 3rd which is quite interesting because this was after the Federal Reserve decided to taper asset purchases. The Eco Watchers Survey, current account and trade balance are the numbers to watch for Japan next week.

Kathy Lien
Managing Director

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