FX: Don’t Expect Much Volatility from Payrolls

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Daily FX Market Roundup 11-01-12

**We are currently at a Trading Expo in Vegas. Publication schedule will return to normal on Tues

FX: Don’t Expect Much Volatility from Payrolls
GBP: Weaker Manufacturing Activity Drives Underperformance
CAD: Looking for Pullback in Job Growth
AUD: Manufacturing Contraction Slows
NZD: China Reports Expansion in Manufacturing Sector
JPY – Japanese Firms on Acquisition Spree

FX: Don’t Expect Much Volatility from Payrolls

For the FX market, the non-farm payrolls report is one of the most important pieces of economic data. It can create significant intraday volatility in currencies and in some cases cause a reaction that can lasts for many days. Jobs form the backbone of every economy and for the U.S. in particular, the health of the labor market is the single most important driver of monetary policy. The high level of unemployment prompted the Federal Reserve to announce a third round of Quantitative Easing and the recent improvements in the labor market has many investors wondering whether the Fed will withdraw monetary stimulus early. According to the latest FOMC meeting, policymakers have not been swayed by the improvements in data including the steep drop in the unemployment rate in September. Having just increased asset purchases a little over a month ago, the Fed won’t be looking to recall their decision anytime soon. September was a very good month for the U.S. economy but the central bank will need to see a sustained decline in the unemployment rate before they would even consider removing monetary policy. Last month, we saw the unemployment rate drop to 7.8%, the lowest level since President Obama took office and yet the Fed barely mentioned the improvement in their October monetary policy statement. According to Fed President Rosengren, the unemployment rate would need to fall below 7.25% for the Fed to stop buying bonds. Tomorrow, the unemployment rate is expected to rise to 7.9%.

Unlike last month’s release, we don’t expect many fireworks from tomorrow’s non-farm payrolls report. First and foremost, many traders in the Northeast are still unable to return to work due to the damage and power outages caused by Hurricane Sandy. Secondly, most of the leading indicators for NFPs point to stronger job growth. This morning we saw jobless claims drop from 372k to 363k and ADP employment increase to 158k from 114k. While Challenger Grey & Christmas reported a 11.6% increase in layoffs, the overall improvement in consumer confidence and increase in other labor market indicators gives us good reason to believe that non-farm payrolls increased in the month of October. Economists are currently looking for payrolls to rise to 125k from 114k, which is encouraging but not enough to inspire renewed gains in the dollar. There have been many signs of improvement in the U.S. economy but until the improvements are consistent enough to trigger a change a monetary policy, the Federal Reserve will still view them with caution. Therefore unless payrolls rise by 200k or more or the unemployment rate drops to 7.6%, we don’t expect much of a reaction in the U.S. dollar. If payrolls surprise to the downside, investors would probably attribute the deterioration to more realistic depiction of the U.S. labor market. Of course, if payrolls are extremely weak and rise by less than 100k or the unemployment rate rises back to 8%, then the dollar would sell off more aggressively. Our view is that payrolls will come in between 115k-140k, which would not cause much volatility for the U.S. dollar or other currencies.

GBP: Weaker Manufacturing Activity Drives Underperformance

Unlike many of the other major currencies, the British pound struggled to hold onto its gains against the U.S. dollar and euro. In contrast to the improvements in manufacturing activity seen in the U.S., China and Australia, manufacturing activity in the U.K. contracted at a faster pace in the month of October. While the decline in the index from 48.1 to 47.5 was small, broad based weakness in underlying components suggests that economic activity could weaken in the fourth quarter. September was a very good month for U.K. data but we are beginning to see renewed signs of weakness in October. Yesterday it was U.K. consumer confidence and today, it is manufacturing PMI. If next week’s PMI services report declines as well then its time to worry. However not all news was bad news. House prices rebounded 0.6% in October after falling 0.4% in September. Low interest rates and the government’s Funding for Lending Scheme continue to provide support to the sector. There are no U.K. economic reports on Friday.

CAD: Looking for Pullback in Job Growth

All three of the commodity currencies traded higher against the greenback thanks to stronger manufacturing activity in Australia and China. While Australian manufacturing activity contracted for the eighth consecutive, the pace of contraction slowed in the month October, which suggests that the manufacturing sector could finally be getting back on track. The possibility of stronger economic conditions going forward was reinforced by the rise in Chinese PMI. According to the Chinese government’s official reports, manufacturing activity expanded for the first time since July. Although a private survey by HSBC still sees the sector contracting, they also report a significant improvement and confirm that the manufacturing sector in China is gaining momentum. Both reports show China not only poised for a soft landing but starting to regain momentum, which is very positive for Australia’s economy. Between the recent rate cut by the RBA and stronger Chinese data, we could begin to see a new trend of stronger Australian data. Producer prices are due for release from Australia this evening and an increase in PPI could compound the rally in the AUD. Canadian employment numbers are due for release on Friday and after very strong job growth in September, a pullback is expected in October. Since net job losses are not expected, the unemployment rate should remain unchanged at 7.4%

JPY – Japanese Firms on Acquisition Spree

With U.S. equities rebounding smartly, the Japanese Yen traded lower against all of the major currencies. There was no economic data from Japan but better than expected data from the U.S. and China helped to ease safe haven demand for the Yen. The big story out of Japan was the Federal Reserve’s approval of Sumitomo’s plans to acquire 9.9% of the voting shares of Hong Kong’s third largest bank – the Bank of East Asia. There’s not much information on whether this is a stock or cash deal and while this is not a Japanese acquisition of a U.S. firm, the Hong Kong dollar is pegged to the U.S. dollar, which means the transaction could require sale of Yen and purchases of U.S. dollars. The recent large scale acquisitions of foreign companies by Japanese institutions suggests that firms in Japan aren’t as cash strapped as many believe. The economy may be weak but Japan is still home to some of the largest and most powerful companies in the world who have taken advantage of the recent strength of the Yen by going on a buying spree. With no major economic data on the calendar, it should be another quiet night in Japan but volatility should pickup during the U.S. hours courtesy of Friday’s U.S. non-farm payrolls report.

Kathy Lien
Managing Director

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