Has Non-Farm Payrolls Killed the Dollar?

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Daily FX Market Roundup 09-06-13

Has Non-Farm Payrolls Killed the Dollar?
CAD – Poised for More Losses
AUD – Busy Week for China, Gold Edges Higher
NZD – Extends Gains, Day’s Best Performer
EUR – More Political Trouble in Italy?
GBP – Ends Week Strong Despite Data Disappointments
JPY – Optimism from the BoJ

Has Non-Farm Payrolls Killed the Dollar?

In December 2012, the Federal Reserve tied interest rate hikes to the unemployment rate, making it clear that job creation is their number one focus. This is the reason why today’s non-farm payrolls report was so important because the central bank has a tough decision to make in less than 2 weeks. Whether it is a mistake or not, policymakers have been extremely vocal about their intention to reduce asset purchases and through their comments, they have effectively committed to a major policy change before the end of the year. Up until today’s release, the lack of consistent improvements in U.S. data has investors divided on when the central bank will act and today’s non-farm payrolls report doesn’t make the decision any easier.

Payroll growth was weak and despite the decline in the unemployment rate, the labor participation rate hit a 35 year low but a number of Fed Presidents including FOMC voter Esther George who spoke after the jobs number today still believe that the central bank should taper this month. In fact, George called for asset purchases to be cut by $15 billion in September with future purchases split evenly between Treasuries and mortgage-backed securities. Granted, George has voted against continued QE for the past 5 meetings, her views may not be a huge departure from her colleagues. Based purely on the decline in the unemployment rate, the Federal Reserve should begin to taper. Back in June, Bernanke said the Fed would begin to reduce the size of its asset purchases later this year and end them completely next year. They added that, “In this scenario when asset purchases ultimately come to an end the unemployment rate would likely be in the vicinity of 7%.” The jobless rate is now at 7.3%, which is not far from this targeted level but people dropping out of the workforce and not stronger labor market conditions are credited for the decline. So the Fed has a difficult decision before them and while the chance of a reduction in asset purchases in 2 weeks time has declined, it is not off the table and for this reason, the NFP report has hurt but has not killed the dollar rally completely, although further position adjustments are likely.

We know there is a high level of support inside the central bank to reduce asset purchases and the only question is timing, With the recovery in bond prices and fall in U.S. yields, there may not be a better time for the Fed to taper. If they stay on course, any changes in monetary policy will be symbolic which means they could opt for an incremental reduction wrapped around by a dovish FOMC statement to prevent a rebound in yields. Between the slowdown in the labor market recovery, debt ceiling debate and geopolitical tensions, the Fed could also delay their changes to December but the proximity of the holidays and the end of Bernanke’s term makes this option less palatable. Retail sales are scheduled for release next week but it is the only piece of U.S. data on the calendar worth watching. Considering that the report is not due until Friday, investors will most likely spend the week digesting the payrolls data and Chinese economic reports. A number of key releases are expected including that Trade Balance that could drive risk appetite in an otherwise quiet week.

CAD – Poised for More Losses

U.S. dollar weakness drove commodity currencies higher but in the case of the Canadian dollar, better than expected economic data also contributed to the move. The focus today may have been on the U.S. jobs number but Canada released its employment report and unlike the U.S., the data was strong. Nearly 60k jobs were created last month, driving the unemployment rate down to 7.1%. Labor market numbers from Canada can be volatile on a month to month basis but today’s report not only offsets the past 2 months of job losses but was the second strongest month of job growth in nearly 1.5 years. While most of the gains were in part-time work, the availability of jobs period has boosted the participation rate to 66.6%. Manufacturing activity also expanded in the month of August after contracting for the first time this year in July. The uptick was small but still puts the Canadian economy on the road to recovery. With the 1.06 level in USD/CAD being rock solid resistance, the better than expected economic reports was a perfect reason for the pair to officially reject the level. Looking ahead, we expect further losses in USD/CAD with a potential drop below 1.03. Meanwhile the Australian and New Zealand dollars also traded higher despite weaker construction sector activity. So far it seems that othere have only been improvements in the manufacturing sector because the service and construction sectors contracted at a faster pace in the month of August. As a result, we don’t expect any major improvement in next week’s Australian employment report. No economic data was released from New Zealand but the currency continued to power higher, rising the most against the U.S. dollar today. There’s not much to explain the outperformance of the NZD outside of a short squeeze that could face some resistance if the RBNZ expresses concerns about the level of the currency.

EUR – More Political Trouble in Italy?

The euro may have rebounded against the U.S. dollar today but its strength had nothing to do with the outlook for Europe. Instead dollar weakness lifted the pair, which previously hit a fresh 6-week intraday low after softer German economic reports. When the ECB met on Thursday, they expressed caution about the outlook for the Eurozone economy, warning that it is too early to be overly enthusiastic about the region’s recovery. Their concerns were validated today with the decline in German industrial production and drop in the country’s trade surplus. The outperformance of the German economy carried the region for most of the recovery and now signs of weakness has everyone worried. While the EUR/USD could rally simply because of dollar weakness, we don’t expect the move to extend beyond 1.34 in the near term and are skeptical of whether the currency pair would reach this level at all. There’s not much in the way of Eurozone data next week but pressure on the euro could come from political trouble in Italy. On Monday, the Senate subcommittee will discuss the possibility of expelling Berlusconi out of the government. The risk here is that Berlusconi threatened to withdraw his party’s support for the current government if he is expelled but given the stakes, it is not clear whether he will follow through with this threat. If he does, it could mean the need for new elections, which would intensify the political crisis in Italy.

GBP – Ends Week Strong Despite Data Disappointments

The British pound performed extremely well this week against the U.S. dollar and euro despite today’s data disappointments. Industrial production growth stagnated in the month of July after rising 1.3% in June while the trade deficit widened to one of the largest levels ever. A steep 7.6% decline in exports was met with a 1% decline in imports. Demand was particularly weak outside of the European Union as exports out of the E.U. plunged 16%. The only good news was manufacturing production, which expanded for the second consecutive month. Sterling bulls cut back on their long positions in reaction to this morning’s U.K. reports but the GBP recovered its losses against the USD after non-farm payrolls. Today’s reports explain why monetary policy members remain pessimistic but the recent increase in the manufacturing, service and construction should not be overlooked as they signal the possibility of healthier growth ahead. According to the Bank of England / GfK Quarterly Inflation report, the central bank’s inflation expectations are at a 3 year low, which is more pessimistic than the market’s expectations. The most important piece of U.K. data next week will be jobless claims and a stronger number could help sterling sustain its gains.

JPY – Optimism from the BoJ

The Japanese Yen traded higher against all of the major currencies today led by the weakness in USD/JPY. While the Bank of Japan’s monthly economic report was a bit more optimistic, the sell-off in the USD/JPY and the other Japanese Yen crosses were driven entirely by the disappointing U.S. non-farm payrolls report, which caused the dollar to weaken. The outlook for Japan on the other hand is bright according to the central bank who believes that industrial production and exports will continue to recover. According to the BoJ, “given an expected moderate recovery in domestic and overseas demand, wide-ranging industries are likely to show increases led by manufacturers of transport equipment, general machinery, electronic parts and devices. Therefore industrial production as a whole is expected to continue increasing.” They also felt that “Exports are expected to increase moderately mainly against the background of the pick-up in overseas economies.” In other words, their optimism is driven as much by their expectation for stronger global growth as by their outlook for Japan’s economy. As a result, the BoJ now feels that “Japan’s economy is recovering moderately” instead of just “starting to recover.” There is quite a bit of Japanese data scheduled for release next week including revisions to second quarter GDP. Q2 growth is expected to be revised up to 1% from 0.6%.

Kathy Lien
Managing Director

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