Will Payrolls Kill the Dollar Rally?

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Daily FX Market Roundup 09.05.14

Will Payrolls Kill the Dollar Rally?

Euro Dead Cat Bounce

USD/CAD: Comfortably Above 1.08 After Softer Data

AUD: Supported by Rise in PMI Construction Index

NZD: RBNZ Meets Next Week

Sterling Deserves to Rally

USD/JPY Backs Off Key Resistance

Will Payrolls Kill the Dollar Rally?

By all counts the U.S. dollar is extremely overbought and due for a correction. Friday’s surprisingly weak non-farm payrolls report triggered a pullback in the currency but in light of its strong rally this week, the decline was extremely modest. Payroll growth missed expectations by an eye-popping 88k and the magnitude of the miss should have triggered a more significant sell-off in the greenback. According to the Bureau of Labor Statistics, only 142k jobs were created in the month of August, the weakest pace of growth this year. Economists were looking for jobs to rise by 230k. The unemployment rate declined to 6.1% from 6.2% while average hourly earnings rose 0.2% in August. Part of the improvement in the jobless rate can be attributed to labor force participation, which dropped to its lowest level since 1978. With this in mind, the dollar is propped up by broader fundamental drivers that remain unchanged despite one month of weak job growth. We believe that the Federal Reserve will still end Quantitative Easing in October and the only caveat is that when Janet Yellen speaks after this month’s FOMC meeting, she will most likely provide zero insight on the timing of rate rises, downplaying expectations for earlier tightening. Many market participants are also suspicious about the accuracy of the latest jobs number particularly since the unemployment rate declined and average hourly earnings increased. One month of weak job growth does not make a trend especially since the August report can be volatile and subject to revision. For these reasons, we do not believe that the slowdown in job growth will kill the dollar rally. Investors have been piling into the greenback because of the lack of better alternatives, which is even truer after ECB easing. While the dollar could experience a further correction in the coming week, we expect the decline to be shallow and short-lived as investors view it as an opportunity to buy at lower levels. The only piece of U.S. data worth watching next week is Friday’s retail sales report. Considering that the front of the week is extremely quiet, FX traders should keep an eye on equities and Treasuries.

Euro Dead Cat Bounce

The euro rebounded against the U.S. dollar today on the back of softer U.S. job growth and a ceasefire between Ukraine and Russia. We will see how long this ceasefire lasts but for the time being, it should bring some relief to European officials. Unfortunately we believe that today’s modest rebound is nothing more than a dead cat bounce for EUR/USD. The Fed will still end QE in October and the U.S. economy is outperforming the Eurozone. Yes, EUR/USD is deeply oversold and the ECB’s decision probably attracted even more sellers, leaving the currency pair vulnerable to a short squeeze but if speculators refuse to give up on their short positions after Friday’s non-farm payrolls report, there’s nothing on next week’s calendar to encourage them to do so. The significance of this week’s announcement from the European Central Bank should not be underestimated. By cutting interest rates and preannouncing ABS purchases, the central bank sent a very strong message to the market. Not only has their concern about the outlook for inflation and growth increased but they feel that they can’t afford to wait until the new 4 year loans are rolled out later this month. Another way to look at this is that they don’t feel TLTRO alone will be enough to revive the economy. As a result, they cut the benchmark rate to 0.05% and the depo rate to -0.2%, a step that took 2 year French and German rates into negative territory. Details on the ABS program will be released next month and based on Draghi’s comments, we can expect a sizeable package. At the same time, we think the ECB is done for the year. While Quantitative Easing remains on the table, there’s now a massive amount of stimulus in the pipeline including the TLTRO, ABS and rate cut. The ECB will now want to see how well these measures are received by the market and the economy before considering a more nuclear option like QE, which is not even legally feasible at this time. However this will not stop the EUR/USD from heading lower because we are still waiting for the details on the ABS program to be announced in October. The next support level that we are looking at is 1.2750.

USD/CAD: Comfortably Above 1.08 After Softer Data

Softer than expected Canadian data helped USD/CAD end the week comfortably above 1.08. After a strong month in July, economists were looking for job growth to slow in August but no one anticipated job losses. Unfortunately the Canadian economy lost 11k jobs last month, with the private sector experiencing the largest decline ever. Over 100k private sector jobs were lost and the only reasons why overall job losses were contained was because 86.9k workers listed themselves as self-employed and the government added 14k public sector jobs. The shift in the balance of jobs is disconcerting because it signals potential weakness in the corporate sector. According to the IVEY PMI report, manufacturing activity also slowed. The index dropped from 54.1 to 50.9 in the month of August putting it barely in expansionary territory. With no major Canadian economic reports scheduled for release next week, we expect USD/CAD to hold 1.08. Meanwhile both the Australian and New Zealand dollars rebounded against the greenback. Next week is a busy week for both countries with Chinese trade numbers scheduled for release along with a RBNZ rate decision and employment report from New Zealand.

Sterling Deserves to Rally

It was a surprisingly difficult week for the British pound. Sterling dropped from a high of 1.6445 to a low of 1.6283 against the U.S. dollar and it also lost value against the euro (albeit the decline was small) despite mostly better than expected U.K. data and bold easing measures from the European Central Bank. Scottish independence fears contributed to the decline but at the end of the day, we do not believe that Scotland will successfully break from the U.K. The ECB’s decision to increase stimulus reduces the motivation for earlier tightening by the Bank of England but at the end of the day, the next step for the Brits is to reduce stimulus whereas the ECB is still considering Quantitative Easing. Although manufacturing activity slowed, the increase in service and construction sector activity along with rise in mortgage approvals and consumer credit reinforces the recovery in the U.K. economy. Stronger data, the likelihood of Scottish independence and the divergence in UK-EZ monetary policy are all reasons why we believe sterling deserves to rally. Of course, if the polls continue to narrow, it may be difficult for sterling to gain upside momentum but at the end of the day. The U.K. trade balance and industrial production reports are scheduled for release next week, but the main focus will be on the speeches by BoE Governor Carney and other MPC members. In terms of event risks, the next 2 major market movers for the pound will be the BoE minutes, which are scheduled for release on September 17th and the Scottish referendum on September 18th.

USD/JPY Backs Off Key Resistance

The weaker than expected U.S. non-farm payrolls report drove USD/JPY and nearly all of the Japanese Yen crosses lower. The currency pair hit a 5-year high of 105.70 during the Asian trading session but ended the day right around 105. Although this constitutes a failed attempt to break through key resistance posed by the January high, we believe that the pullback is temporary. USD/JPY could fall to 103.50 but most investors will view this as an opportunity to buy at lower levels. The main focus for Japan next week will be the revisions to GDP and Industrial Production. Based on the decline in the leading and coincident index, Japan’s economy continues to suffer from a loss of momentum even though the central bank remains optimistic about its resiliency. The BoJ released its Monthly Economic Report last night and their assessment was unchanged. They said, “Japan’s economy has continued to recover moderately as a trend, although the subsequent decline in demand following the front-loaded increase prior to the consumption tax hike has been observed.” Meanwhile Prime Minister Abe’s approval rating rose 11 points to 60% after this week’s Cabinet shuffle.

Kathy Lien
Managing Director

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