Between the positive surprises in U.S. data and less dovish comments from the ECB, it has been an extremely busy morning in the foreign exchange market. EUR/USD climbed to its highest level in more than a month while USD/JPY dropped below 102. We are a bit surprised by the weakness in USD/JPY because lower jobless claims and the sharp upward revision to Q3 GDP should have been positive for the dollar. While bond traders drove yields higher after the data, the U.S. dollar and stocks erased their initial gains. Part of the weakness can be attributed to concerns that stronger growth in Q3 means weaker growth in Q4. Even Federal Reserve President Lockhart expressed his skepticism about the latest release by saying that a strong third quarter GDP report does not make a trend. However if non-farm payrolls rise by more than 165k tomorrow, tapering in December is still on the table.
Meanwhile investors are loading up on euros this morning after ECB President Draghi reassured investors that they are in no rush to ease again. As expected, the European Central Bank and the Bank of England left monetary policy unchanged. The ECB upgraded its GDP forecasts for next year by 0.1%, talked about the positive developments in the economy since the last monetary policy meeting and downplayed the need for negative rates. According to Draghi, the committee only discussed this option briefly and while they are technically ready to take rates below zero, they see no reason to do so now. He also explained that the situation today is fortunately substantially different from when they did LTRO 2 and this implies that there is no urgency to introduce another long term refinancing program when the current one ends. The only problem is that the central bank now expects inflation to remain below their 2% target for the next 2 years. In line with the recent drop in CPI, they revised down their 2013 and 2014 inflation forecasts. Easy monetary policy should support a slow and gradual recovery in the coming year. The bottom line is that the ECB is comfortable with the current level of monetary policy and wants to see how the economy responds to the last rate cut before deciding whether additional action is necessary. With negative rates no longer an imminent threat to the euro, the currency could aim for its yearly highs against the dollar if payrolls surprise to the downside.
As for USD/JPY, tomorrow’s non-farm payrolls report will determine whether the currency pair holds 102 or drops to 100. For the second time this year, fewer than 300k jobless claims were filed last week. Economists expected claims to rise but instead, it fell to an almost 6 year low of 298k. Even though fewer layoffs may not translate into more hiring, the consistent decline in jobless claims over the last 4 weeks is positive for non-farm payrolls. However with yesterday’s ISM report showing employment growth slowing in the service sector, the dollar’s rally has been limited because investors are eyeing these conflicting reports with caution. The same can be said for U.S. GDP. While GDP growth was revised up to 3.6% from 2.8%, the move was driven by the largest rise in inventories in 15 years. This increase in inventories reflects expectations for stronger consumer demand but with personal consumption growth growing at its slowest pace since 2009, the appetite of consumers remain week but there is hope based upon Thanksgiving Thursday, Black Friday and Cyber Monday sales.