Will Non-Farm Payrolls Erase the Dollar Gains?

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Daily FX Market Roundup 11-07-13

Will Non-Farm Payrolls Erase the Dollar Gains?
ECB Kills the EUR with 25bp Rate Cut
GBP: Supported by Steady Policy
CAD: Weak Employment Report Could Drive Pair to 1.05
AUD: Hit by Drop in Full time Employment
NZD: Keep an Eye Out for Chinese Trade Numbers
JPY: BoJ Says Too Early to Even Think about an Exit

Will Non-Farm Payrolls Erase the Dollar Gains?

The U.S. dollar traded higher against all of the major currencies today except for the Japanese Yen and this tells us that risk aversion played a bigger role in the dollar’s rise than the stronger GDP numbers. In fact, the 1% slide in the S&P 500 and the drop in U.S. Treasury yields suggest that investors are nervous about Friday’s non-farm payrolls report and the potential of faster growth speeding up the Federal Reserve’s timeline for reducing asset purchases. The U.S. economy expanded by 2.8% in the third quarter up from 2.5% in Q2. Economists expected growth to slow to 2% but strong inventory buildup offset weaker consumer spending. This consistent improvement in U.S. data eases the market’s concerns about a weak U.S. recovery and raises the odds of earlier tapering by the Federal Reserve. At the start of the North American trading session, the EUR/USD was the biggest loser but by the end of the day losses in USD/JPY and AUD/USD exceeded the move in the euro. However with the U.S. government shutdown for most of October, many investors are wondering if payrolls will erase the dollar’s gains and ease concerns about earlier tapering.

On average, economists are looking for non-farm payrolls to rise by 120k in the month of October, down from 148k the previous month. Unfortunately the range of estimates is wide with the most pessimistic economist calling for only 50k job growth and most optimistic forecasting a rise of 175k jobs. Investors are bracing a weaker release because the government shutdown put hundreds of thousands of federal employees and private contractors out of work for weeks. While non-farm payrolls could move lower like economists expect, based on the ISM manufacturing and service sector reports, the U.S. government shutdown did not have a significant impact on the U.S. economy and may not have a significant impact on payrolls. More than half of the furloughed workers were called back to work early on in the shutdown and if a worker was recalled on a part time basis for just 1 day during the first 2 weeks of the month, they would be included in payrolls. We have seen a significant decline in consumer confidence but lower jobless claims, the increase in the employment component of non-manufacturing ISM, decline in job cut announcements all suggests that payrolls could surprise to the upside, which could propel the dollar even higher. However there are also valid arguments for weaker payrolls growth. We have seen a drop in the ADP employment survey along with a decline in the employment component of the ISM manufacturing index. Most importantly, hiring plans could have been delayed by the shutdown. In other words, the upside risk for the dollar is just as high as the downside risk and this means tomorrow’s payrolls report should be a big mover for the dollar.

At the end of the day when the payrolls report is released we have to ask ourselves how much this actually affects Fed policy. If payrolls are strong, the string of positive surprises would harden the case for earlier tapering, though we still believe the Fed will move in 2014 and not 2013. Even if payrolls are weak investors will expect revisions and a bounce back in November.

ECB Kills the EUR with 25bp Rate Cut

The European Central Bank killed any chance of a euro rally today after they slashed interest rates by 25bp to 0.25% and extended their fixed rate allotment to 2015. The market was caught completely off guard because less than 10% of economists anticipated the move and an even smaller amount of investors were positioned for lower rates. So when the announcement was made, the EUR/USD dropped like a hard rock through 1.35, 1.34 to test 1.33. The currency pair bounced off the last big figure, but we believe the combination of a dovish ECB and stronger U.S. data should keep a EUR/USD rebound capped below 1.3450. Having done very little to prepare the market for the move, the ECB rate cut shows that European policymakers are deathly afraid of low inflation turning into deflation. According to Draghi, there are no signs of deflation at this time and the goal of today’s move was to shorten the period of low inflation. However with producer prices declining and consumer price growth at a 4 year low, the central bank knows that the Eurozone could turn into the next Japan if they fail to reverse the downtrend in price pressures.

By lowering rates today and not in December, the ECB is leaving the door open to additional easing over the next 2 months. The fact that all members of the ECB felt that lower rates are needed, but not everyone believed that it was necessary to pull trigger this month tells us that policymakers could ease again if growth or inflation weakens further. While the ECB is running short of options, they have not exhausted all of their policy tools. According to Draghi, the ECB is technically ready to cut the deposit rate and according to previous ECB comments another LTRO is also possible. When the ECB staff forecasts are released next month, we expect the growth and inflation forecasts to be lowered because the decline in inflation was stronger than anticipated and their concerns about high unemployment and weak economic conditions intensified. The central bank expects only modest growth with balance sheet adjustments, high commodity prices and market conditions weighing on activity in the months ahead, posing greater downside risks to their economic outlook. Mario Draghi made it clear that the ECB is not done easing because they haven’t reached the lower bound and if the central bank is serious about preventing deflation, they will need the euro to weaken further which is one of the reasons why do not expect a significant recovery in the currency. With the gap between U.S. and Eurozone monetary policies only expected to widen over the next 4 or 5 months we are looking for a deeper slide in the EUR/USD that could involve a test of 1.3325.

GBP: Supported by Steady Policy

One of the best performing currencies today was the British pound, which rose to its strongest level against the euro since mid January and held steady against the U.S. dollar. As expected, the Bank of England of England left monetary policy unchanged. No details were provided in the monetary policy statement but steady policy was enough for investors to bid up the currency. Improvements in U.K. data leaves the BoE comfortable with the existing level of stimulus and while that may not be positive for the GBP/USD because the Federal Reserve is gearing up to reduce stimulus, it is certainly positive for EUR/GBP, after today’s surprise 25bp rate cut from the ECB. With the currency pair trading at a 9 month low, there is no major support in EUR/GBP until 82 cents. Looking ahead, the country’s visible trade balance is scheduled for release tomorrow and a narrower deficit is expected after the jump in industrial production in the month of September. Good data would compound gains for sterling against the euro and U.S. dollar.

CAD: Weak Employment Report Could Drive Pair to 1.05

While the rally in the U.S. dollar today drove the Australian, New Zealand and Canadian dollars sharply lower, some of the commodity currencies were also pressured by weaker economic data. Despite the uptick in manufacturing, service and construction sector activity, only 1100 jobs were created last month. Economists had been looking for job growth to rise by 10k, but the disappointment in October was accompanied by a downward revision in September. Between September and October, less than 4500 jobs were created but the report was made worse by the fact that all of the job growth last month was in part and not full time jobs. A total of 27.9k permanent workers lost their jobs and the month prior the 5k full time job growth was revised to a loss of 1.8k. As a result the unemployment rate held steady at an upwardly revised 5.7%. This deterioration explains why the Reserve Bank refused to appear more optimistic this week despite the improvements in Australian and Chinese PMIs. With New Zealand house prices growing faster in the month of October, we are still looking for additional losses in AUD/NZD. Chinese trade numbers are scheduled for release over the next 24 hours but the release time is undetermined. An uptick in exports and rise in China’s trade surplus could stabilize the AUD. The Canadian dollar will also be on the move tomorrow with employment numbers scheduled for release. While job growth is expected to remain steady, economists are looking for a higher unemployment rate. Despite a strong rise in the IVEY PMI index, the employment component of the report fell sharply, signaling weaker job growth that could drive USD/CAD back up to 1.05.

JPY: BoJ Says Too Early to Even Think about an Exit

As it is a light week in terms of Japanese economic data and a heavy week for data from other parts of the world, the Yen traded purely on the market’s demand for dollars. The Yen appreciated against all of the major currencies today with the exception of the greenback after the stronger than expected U.S. GDP report. If U.S. stocks firmed after the GDP number, the sell-off in the Yen crosses may not be as deep but equities were weighed by the concern that stronger growth would lead to faster tapering. The biggest loser was EUR/JPY, which was hit from both sides by the ECB rate cut and U.S. GDP report. The only numbers out of Japan were the country’s leading and coincident, which were right in line with expectations and consistent with a continued recovery in the economy. We also heard from Bank of Japan Governor Kuroda and Deputy Governor Iwata, both of whom said it is too early to talk about exit strategy but the central bank has various methods to reduce its assets when the time comes. No major Japanese economic reports are scheduled for release tomorrow but there was a saddening statistic released today – the percentage of Japanese households with no savings rose to its highest level ever (the survey began in 1963). A total of 31% of Japanese have no financial assets, up from 26% a year prior, making raising wages is a key priority for Prime Minister Abe’s government.

Kathy Lien
Managing Director

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