Dollar Outlook – What Worries Us About NFPs

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Daily FX Market Roundup 03.05.15

Dollar – What Worries Us About NFPs

Euro Hits Fresh 11.5 Year Lows, QE Begins March 9th

CAD – Dismisses Stronger IVEY PMI

NZD Crushed by RBNZ

AUD – Pressured by Weaker GDP Forecast for China

EUR/GBP Hits Fresh 7 Year Lows

Dollar – What Worries Us About NFPs

The U.S. dollar traded higher against all of the major currencies ahead of Friday’s non-farm payrolls report. This price action suggests that investors are looking for a strong jobs number to reinforce their view that the Federal Reserve will raise interest rates in June. We are continually surprised by this aggressive forecast because there has been more deterioration than improvement in the economy over the last month. Most of the voting members of the FOMC also favor patience over haste. However with the European Central Bank set to begin buying bonds on March 9th and the central banks of China, India and Poland surprising the markets with interest rate cuts this week, the Fed’s plan to raise rates this year has made the dollar very attractive. Whether these gains continue in the near term will hinge in large part on tomorrow’s labor market report. According to the eight leading indicators for labor market activity that we follow each month, there’s a reasonable chance for a negative surprise in tomorrow’s NFP report. This morning we learned that jobless claims rose to its highest level in 9 months and on a 4 week moving average basis, claims are at their highest in 6 weeks. Continuing claims also inched upwards, job cuts rose 20% according to Challenger Grey & Christmas, companies added fewer workers to their payrolls according to ADP and consumer confidence declined. The only argument for an upside surprise is the rise in the employment component of the ISM non-manufacturing report. This highly correlative index should not be ignored but with the odds stacked against a weaker release, there’s a greater chance of weakness than strength in tomorrow’s report. If we are right, the dollar could finally experience it’s a much needed retracement. However we certainly do not expect an abysmal NFP number. Payrolls should still rise more than 200k, but unemployment rate could hold steady and average hourly earnings growth cold slow slightly after the sharp rise last month. In other words, tomorrow’s report won’t eliminate the chance of a rate hike by the Fed this year but it should delay it.

Arguments for Stronger Payrolls

1. Rise in Employment Component of ISM Services

Arguments for Weaker Payrolls

1. Jobless Claims 4 Week Moving Average Rises to 304.7k from 293K

2. Continuing Claims at 2.42M from 2.4M

3. Lower ADP Employment Change

4. 20% Rise in Job Cuts According to Challenger Grey & Christmas

5. Drop in University of Michigan Consumer Sentiment Survey

6. Steep Decline in Consumer Confidence Index

7. Drop in Employment Component of ISM Manufacturing

Euro Hits Fresh 11.5 Year Lows, QE Begins March 9th

March 9th marks the beginning of Quantitative Easing in the Eurozone. Next Monday, the European Central Bank will buy EUR60 billion worth of government bonds per month until September 2016. The program could extend beyond that date if a sustainable 2% inflation rate is not reached but right now, investors are focused on the fact that the ECB will be flooding the markets with liquidity for the next 18 months. Mario Draghi did not express any concerns about the difficulty of finding government bonds to buy and he indicated that they would be even be buying bonds with negative rates. While the central bank lowered its inflation forecast significantly, justifying the start of Quantitative Easing, they also raised their GDP forecast for 2015 and 2016 by 0.4% each. Nodding to the recent improvements in Eurozone data, Draghi said they have already began to see the positive effects of stimulus with borrowing conditions, money, credit dynamics, consumer and business sentiment improving. He also indicated that Q4 growth was stronger than expected and data points to a further improvement in the economy going forward. In other words, the European Central Bank is optimistic about the impact that QE will have on the Eurozone economy. The sheer reality of QE drove the euro to a fresh 11.5 year low versus the U.S. dollar during ECB President Draghi’s press conference. The currency pair bounced off its lows by the end of the North American session but EUR/USD needs to rise back above 1.11 and ideally 1.12 to call this a bottom.

NZD Crushed by RBNZ

All three of the commodity currencies traded sharply lower today but the worst performer was by far the New Zealand dollar. NZD/USD fell 1.5%, the largest one-day decline in nearly 6 weeks after the Reserve Bank of New Zealand said they are looking for ways to tighten property lending rules. According to our colleague Boris Schlossberg, “The move is all part of the new macroprudential policy to contain the speculative excess in the New Zealand housing market while still keeping credit affordable to those who want to purchase a home for residence rather than investment purposes. The market took the new measures to mean that the RBNZ would not use interest rate policy to control credit with traders tempering any expectation that the New Zealand central bank would hike rates further.” Reports that China’s economy may expand by less than 7.5% weighed on both the New Zealand and Australian dollars. While retail sales rose 0.4% in the month of January, which was right in line with expectations, Australia’s trade deficit rose to -980M from -503M. Finally the Canadian dollar received zero support from the rebound in oil prices and stronger than expected manufacturing activity. The IVEY PMI index rose to 49.7 from 45.4 in the month of February, reinforcing the Bank of Canada’s view that no additional rate cuts are needed for the time being.

EUR/GBP Hits Fresh 7 Year Lows

The British pound also fell victim to a rising U.S. dollar. Like the European Central Bank, the Bank of England left interest rates unchanged. Unlike the ECB however, the BoE provided no details, which makes the monetary policy announcement a nonevent for the currency. Sterling traders were dismayed by the drop in house prices according to Halifax but the decline is small and does not alter our view that the central bank remains on track to raise rates before the end of the year. Two out of three PMI reports surprised to the upside this week and even though service sector activity slowed, the underlying strength reinforces our positive outlook for the U.K. economy while the recent stabilization in oil prices also supports our rate hike expectations. The best trade has been to buy sterling versus the euro and we believe that the currency pair will drift towards 70 cents. GBP/USD could find support at 1.52 but if it doesn’t the next level to watch is 1.50.

Kathy Lien
Managing Director

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