FX: Could NFPs Disappoint Like ECB?

After today’s strong euro rally, the market’s greatest fear is that the tomorrow’s U.S. non-farm payrolls report will also disappoint. Investors are aggressively short dollars ahead of NFPs on the belief that the jobs data will be healthy enough to give the Fed a green light to raise interest rates this month. We know from Janet Yellen’s comments this week that the Fed chair is ready to raise interest rates. She fears that delaying liftoff would mean more abrupt tightening later than could put the economy at risk of recession. This sentiment appears to be shared by Fed President Williams. Yet despite their hawkish rhetoric, there has been more deterioration than improvement in data over the past week. Manufacturing and service sector activity slowed significantly in November, raising concerns about how good tomorrow’s payrolls report could really be.

Each month we take a look at 8 leading indicators for non-farm payrolls report and this month there are more arguments in favor of stronger than weaker payrolls. However the employment component of the ISM non-manufacturing index fell sharply which is worrisome because as a measure of labor market activity in the service sector, it is one of the most reliable leading indicators for NFP. We can’t ignore this report because last month we had a blowout jobs number, which was consistent with a nice increase in the employment subcomponent of ISM at the time. So this suggests that NFPs could be weaker in October, causing more investors to bail out of their long dollar trades BUT economists are already anticipating softer job growth so unless it is a significantly weak number, losses should be limited because any reading above 150k still keeps liftoff this month in play.

After the December FOMC meeting however our outlook for the dollar will be different because as Yellen said the “Fed can always raise rates and then lower then again,” which clearly indicates that they intend to downplay the rate hike as much as possible.

Take a Look at How the Leading Indicators for Non-Farm Payrolls Shape Up this Month

Arguments in Favor of Stronger Payrolls

• ADP Employment Change Rises to 217k from 196k

• Challenger Reports -13.9% Drop in Layoffs

• Continuing Claims Drop to 2.16M from 2.17M

• Employment Component of ISM Manufacturing Rises

• University of Michigan Consumer Sentiment Index Rises

Arguments in Favor of Weaker Payrolls

• Sharp Drop in Employment Component of ISM Non-Manufacturing

• 4 Week Moving Average of Claims Rises to 269K from 262K

• Consumer Confidence Index Plunges to Lowest Level Since Sept

The big story today is the ECB’s monetary policy decision. EUR/USD experienced its strongest one-day rise since 2009 after the central bank announced fresh stimulus measures. The short squeeze in the currency pair tells us that investors were hoping for more – they wanted the ECB to lower the deposit rate by 20bp and to increase the amount of bonds purchased but instead they took only the following actions:

1. Cut the deposit rate by -0.1%

2. Extend QE End Date to at Least March 2017

3. Broaden Assets Bought to Include Regional Debt

4. Reinvest QE

5. Signal that they are Able, Willing to Act with All Tools if Needed

6. Raised 2015 and 2016 GDP Forecasts

7. Lowered 2016 and 2017 Inflation Forecasts

In additional to disappointing the market with less aggressive measures, the ECB also raised its 2015 and 2016 GDP forecasts. In yesterday’s note we provided a table showing more improvement than deterioration in the Eurozone economy since the last meeting but we actually anticipated bolder action from a central bank that pledged to do what they must to return inflation to 2% as quickly as possible. Whether EUR/USD will squeeze higher from here will now hinge on Friday’s non-farm payrolls report.

Between the OPEC meeting and U.S./Canadian employment reports, USD/CAD will also be in play tomorrow. Apparently the Saudis at the informal pre-meeting proposed no production cuts and if this is accurate it poses greater downside than upside risk for oil and the Canadian dollar. Labor market numbers are also expected to be weaker in November than October when job growth surged unexpectedly. In other words, USD/CAD’s 11 year high of 1.3457 could be tested on Friday if weaker Canadian data and lower oil prices are met with stronger U.S. payrolls.

Broad based U.S. dollar strength and better than expected U.K. data also drove sterling sharply higher. After seeing a slowdown in the manufacturing and construction sectors, investors were bracing for a weak report but the index rose slightly, signaling stronger service sector activity. GBP/USD is now trading firmly above 1.50. There’s resistance near 1.5140 but after that the next target is 1.52.

The Australian and New Zealand dollars also traded higher versus the greenback. The wider trade deficit in Australia was offset by strong Chinese PMIs. Retail sales are due for release this evening. While both currencies moved sharply lower versus the euro today we believe that after the ECB’s rate cut, euro funded carry trades will see more demand which should lead to a reversal in EUR/AUD and EUR/NZD.