FX: Now Onto Non-Farm Payrolls and the USD

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Daily FX Market Roundup 09-06-12

FX: Now Onto Non-Farm Payrolls…
EUR: ECB Announces Unlimited Bond Buys, Keeps Rates Unchanged
GBP: No Changes In Monetary Policy for BoE
CAD: Employment and IVEY PMI Due on Friday
AUD: Net Job Losses But Improvement in Unemployment Rate
NZD: Strongest Gains in Over a Month
JPY: Yen Crosses Benefit from Risk Rally

FX: Now Onto Payrolls….

With the European Central Bank’s monetary policy meeting now behind us, it is time to focus on the U.S. non-farm payrolls report. In some ways, investors are already thinking about payrolls because today’s strong rally in equities and currencies can be largely attributed to better than expected reports on the labor market. Economists initially anticipated a sharp pullback in job growth after seeing non-farm payrolls rise 163k in July but after the latest reports, a number of banks have upgraded their NFP forecasts. More specifically, job cuts eased in the month of August according to Challenger Grey & Christmas while companies added more workers to their payrolls according to ADP. While the ADP report has had a poor record of tracking payrolls, it has been more accurate forecasting the direction of payroll growth. Economists had only been looking for a 140k rise and instead, ADP reported a 201k increase in workers last month. Jobless claims also fell to its lowest level in 4 weeks and most importantly the employment component of ISM non-manufacturing rose to its highest level since April.

According to these leading indicators for non-farm payrolls, job growth could surprise to the upside but not so fast! The main argument for weaker payroll growth is the uptick in jobless claims, which is worrisome. Also, while the employment component of ISM non-manufacturing has a strong correlation with non-farm payrolls, it failed to accurately forecast the uptick in July. The index actually fell from 52.3 to 49.3 that month which means that the rebound seen today to 53.8 could be snapback from prior levels. Consumer confidence has also been mixed with the Conference Board reporting the largest decline in sentiment since October, which contrasts with the increase in the University of Michigan report. Currently economists are looking for payroll growth to slow to 130k, down from 163k the prior month. Based on the other labor market reports, there’s reason to believe that job growth could surprise to the upside but fall short of exceeding the 163k rise reported for the month of July.

Non-farm payrolls is one of those economic reports that can cause tremendous volatility for the forex markets and this month’s number is particularly important because it can determine whether or not the Federal Reserve eases next week. When the Fed Chairman last spoke in Jackson Hole, he did not commit to any changes in monetary policy but made a strong case for more stimulus. At the time, many people believed that he wanted to wait for another non-farm payrolls report before making a decision to ease. If payrolls grow by more than 130k, the central bank could opt to postpone easing but if it rises less than 100k, then QE3 or changes to the extended period language in the FOMC statement could be in play.

EUR: ECB Announces Unlimited Bond Buys, Keeps Rates Unchanged

By all counts the latest European Central Bank monetary policy announcement was a disappointment. Interest rates were left unchanged and the ECB introduced a whole new set of acronyms that sounded glamorous on paper but was lacking in pizazz. Few experts will argue that the ECB could have done more, making small tweaks to their announcement that could have made their new program more impressive. Even an interest rate cut would have shown more resolve. Yet the ECB’s failure to impress did not stop the EUR/USD from rising. The euro fell aggressively immediately after ECB President Draghi laid out the terms of their bond purchase program but as the North American trading session progressed, euro recaptured all of its losses to trade at its highest level in more than 2 months against the U.S. dollar. The euro can thank better than expected U.S. economic data and the rally in equities for its intraday recovery. The good news was that the ECB agreed to purchase bonds of weaker nations on the secondary market to bring down borrowing costs through a program called Outright Monetary Transactions (OMT). The purchases will be on the short end of the curve with maturities of 1 to 3 years, have no minimum credit threshold and are unlimited in size. The central bank will also put themselves on the equal footing with other bondholders, which means giving up their seniority. This will only be for the OMT program and not the Securities Market Programme or SMP. IMF involvement will also be sought which suggests that any nation seeking the help of bond purchases by the ECB could become subject to Troika review if the IMF wants to get involved. In a nod to the Germans, the bad news is that strict conditionality will be attached to the bond purchases so if troubled countries fail to comply with fiscal and structural reforms, these purchases can be cancelled by the ECB. The SMP will also be terminated and replaced by OMT, which isn’t as stimulative as having both programs running simultaneously. The fact that bond purchases will be sterilized is also a disappointment because it waters down the ECB’s influence on the market and the region’s economy by neutralizing the impact on the money supply. The main difference between this program and other bond buying is the conditionality or the Enhanced Condition Credit Line (ECCL). According to ECB President Draghi, this conditionality is important and can mean the difference between the program’s success and failure because it give clear metrics and stakes for governments seeking support from the ECB. Aid could be yanked if nations fail to comply with reform conditions for bond purchases. Looking ahead, the sustainability of the euro’s gains lies in the outcome of non-farm payrolls on Friday, the German Constitutional Court’s decision about the ESM/EFSF next week and the Federal Reserve’s monetary policy announcement.

GBP: No Changes In Monetary Policy for BoE

As expected the Bank of England left interest rates unchanged at 0.5% and maintained its asset purchase program at GBP 375 billion. No action was expected from the U.K. central bank whose meeting took a backseat to the European Central Bank’s rate decision. While the BoE is still in easing mode, recent economic data surprised to the upside, giving the central bank very little reason to act. Also, U.K. policymakers are only halfway through the GBP50 billion gilt purchase program announced back in July. As usual, a statement explaining action was not provided and we won’t hear more from the central bank until the minutes from this meeting are released 2 weeks later. This decision was most likely unanimous because for once, economic data supports steady policy. With this in mind, the level of growth is far from desirable and the Prime Minister’s efforts to reduce the deficit could add further strain on the economy. Don’t forget, the U.K. is still in recession and help from the Bank of England could be necessary to return the country back to growth mode. U.K. industrial production and producer prices are scheduled for release tomorrow and a slightly stronger outcome is expected for both.

CAD: Employment and IVEY PMI Due on Friday

The Canadian, Australian and New Zealand dollars ended the North American trading session higher against the greenback. While the focus tomorrow is on the U.S. non-farm payrolls report, Canada is also scheduled to release its labor market numbers and manufacturing activity report. A 10k rebound in job growth is expected in August after employment fell by 30.4k in July. The Bank of Canada maintained its view that withdrawal of monetary stimulus could become appropriate and it would be credibility buster for them to have done so if job growth fell for the second straight month. Building permits and IVEY PMI are also due from Canada and unfortunately manufacturing activity is expected to retrace after accelerating quickly in the month of August. Last night’s Australian employment report was as confusing as ever. While the country reported net job losses in the month of August, the unemployment rate dropped to 5.1%. This decline partially reflects the drop in the participation rate but masks the growing problems in Australia’s economy. Slower growth in China has not only discouraged hiring but also forced companies to lay off 8,800 workers. All job losses were part time as full time employment held steady. When the RBA last met, they were quietly neutral but given the recent turn in economic data, it may be hard for the central bank to maintain this stance for long. Australian trade numbers are scheduled for release this evening along with construction sector PMI.

JPY: Yen Crosses Benefit from Risk Rally

Thanks to the broad based rally in U.S. equities, Japanese Yen crosses performed extremely well today led by the gains in USD/JPY. It was another quiet night in Japan with no major economic reports released and the only data that we have tonight is leading indicators. Of course the lack of Japanese data has never stopped the Yen from experiencing big swings. Today, the Asian currency dropped more than 1.25 percent against the commodity currencies, the largest move we have seen in over a month. If non-farm payrolls surprise to the upside on Friday, these gains could be extended by a further rally in USD/JPY. Next week will be much more interesting for Japan with GDP, trade and industrial production scheduled for release. Unfortunately the strain of slower global growth and a strong yen will keep lid on domestic growth in Japan for some time.

Kathy Lien
Managing Director

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