EURUSD: NFP Preview, ECB Review

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Daily FX Market Roundup 09.04.14

Will US Payrolls Drive Dollar to Fresh Highs?

EUR Crashes after ECB Eases

USD/CAD: Big Day Ahead

AUD: Supported by Narrower Trade Deficit

NZD: Gold and Oil Prices Move Lower

Sterling Drops to 6 Month Lows

JPY: BoJ Express Confidence in Economy

Will US Payrolls Drive Dollar to Fresh Highs?

Non-farm payrolls are scheduled for release on Friday but after today’s big move in currencies, NFPs could be nothing more than an after thought for most investors. The dollar climbed to fresh multi-month highs versus the euro, British pound, Japanese Yen and Swiss Franc. Better than expected U.S. data contributed to the moves, but it was the European Central Bank’s aggressive decision to cut interest rates and pre-announce ABS purchases that sent European currencies sharply lower. With this in mind, the ECB’s actions shine the light on the superiority of the U.S. economy and monetary policy. The Federal Reserve made it very clear that they are gearing up to end their Quantitative Easing program next month and their next step, whenever they decide to take it, will be to raise interest rates. The narrower trade balance and acceleration in service sector activity will make the central bank even more confident about their plans to roll back stimulus. So while tomorrow’s non-farm payrolls report is important, in all likelihood, monthly job growth was somewhere between 175k to 250k and most likely above 200k – a level that will keep the Fed’s monetary policy plans on track. In other words, there is more upside than downside risk for the dollar tomorrow because as long as job growth exceeds 150k, which is significantly lower than the 230k consensus forecast, the outlook for U.S. policy will remain unchanged. In fact, Cleveland Fed President Mester, who is a voting member of the FOMC this year sounded relatively optimistic today, which means the Fed added another hawk to their roster. We are looking for healthy job growth with payrolls between 230k to 250k and if we are right this would reinforce the U.S. recovery story and drive the dollar to fresh highs versus the EUR, GBP and JPY.

Every month, we take a look at the various labor market indicators to gage the potential strength or weakness of the upcoming non-farm payrolls report and for the most part, they all point to a good number. Service sector employment increased, layoff announcements declined and confidence hit a 6-year high as measured by the Conference Board. While the 4-week moving average of jobless claims ticked up slightly, the overall level is still extremely low and consistent with payrolls in excess of 200k. The drop in employment component of the manufacturing ISM report was small and according to ADP, companies still added more than 200k workers to their payrolls last month. As usual, aside from the absolute amount of job growth, traders also need to keep an eye on the unemployment rate and average hourly earnings but at the end of the day, we don’t expect Friday’s report to pose much threat to strong the uptrend in the dollar.

Arguments for Stronger Payrolls

1. ISM Non-Manufacturing Employment Component Rises to 57.1 from 56

2. Continuing Claims Fall to 2.46 million from 2.55 million

3. Challenger Grey & Christmas reports 20.7% drop in layoff announcements

4. University of Michigan Consumer Confidence Index Rises to 82.5 from 81.8

5. Consumer Confidence Hits 6 year High, Index rises to 92.4 from 90.30

Arguments for Weaker Payrolls

1. ADP reports 204k rise in payrolls, down from 212k

2. ISM Manufacturing Employment Component Drops to 58.1 from 58.2

3. Jobless Claims 4 Week Moving Average Rises to 302k from 293k

EUR Crashes after ECB Eases

The European Central Bank’s decision to roll out a series of new measures today drove the euro to its lowest level against the U.S. dollar since July 2013. The initial decision to cut interest rates by 10bp caused EUR/USD to break below 1.31 and the preannouncement of ABS purchases took the currency pair below 1.30. The next support level that we are looking at for the currency pair is 1.2750. With the divergence in Eurozone and U.S. data and monetary policy expected to widen further this month, it should only be a matter of time before this support is tested with a move down to 1.25 becoming increasingly likely. By opting for the one-two punch of rate cut plus ABS purchases that we suggested in our ECB preview, 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. This will not stop the EUR/USD from heading lower however because we are still waiting for the details on the ABS program to be announced in October. The size and scope of the program will reflect the ECB’s resolve and in turn affect the EUR/USD. Here are my Top 10 takeaways from today’s ECB announcement:

My Top 10 Takeaways from ECB

1. ECB in “Do Everything that it Takes” Mode to Stimulate Economy – Rolls Out NEW Series of Measures as Concerns about Economic Outlook and Inflation Grows

2. Sends Strong Message via One Two Punch – 10bp Rate Cut PLUS Pre-announcement of ABS Purchases, Details on ABS to follow in October

3. Downgrades 2014, 2015 GDP and Inflation Forecasts

4. Signals No Further Rate Cuts – Draghi Says Interest rates are NOW at Lower Bound

5. QE still on the table – Decision was NOT unanimous, some wanted to do more, some less

6. QE was discussed at the latest meeting

7. ECB buying will have substantial impact on Balance Sheet – expect a BIG ABS program

8. Geopolitical Risks and Structural Reforms pose downside risk to economy

9. Low inflation reflects low energy prices

10. Main reason for rate cut was to reinforce lower bound and encourage uptake of TLTRO

USD/CAD: Big Day Ahead

Tomorrow, most investors will be focused on the U.S. non-farm payrolls report, but it is important to remember that Friday is also a big day for the Canadian dollar. The latest labor market and manufacturing activity reports are scheduled for release tomorrow and these 2 key pieces of data will determine if USD/CAD breaks 1.08. On Thursday, a sharp rise in Canada’s trade balance helped to extend gains in the Canadian dollar and the decline in USD/CAD. Canada posted its largest trade surplus in 6 years thanks to strong demand for autos. Their trade surplus rose to C$2.58 billion in July from C$1.83 billion the previous month. Excluding auto and energy, exports still increased 1% that month. This data reinforces the Bank of Canada’s slightly more optimistic outlook and supports further losses in USD/CAD. Chances are manufacturing activity also accelerated in the month of August but after a strong month of employment in July, slower job growth is expected. USD/CAD almost always has a delayed reaction to its employment report. Even though the U.S. and Canada will release labor market numbers at the same time, the currency pair will generally react first to the U.S. report and about 5 to 20 minutes later to the Canadian report. The Australian dollar also extended its gains today on the back of stronger trade numbers. While retail sales growth slowed to 0.4% from 0.6% in the month of July, the trade deficit narrowed to -A$1.349 billion from –A$1.56 billion. The New Zealand dollar on the other hand remained under pressure due in part to a drop in house prices.

Sterling Drops to 6 Month Lows

Sterling fell to a fresh 6 month low against the U.S. dollar on the back of euro weakness. All major European currencies underperformed as investors interpreted ECB easing as a need to keep monetary policy stimulative in other parts of region. As expected, the Bank of England left interest rates and the size of its Quantitative Easing program completely unchanged. The impact on sterling was nominal but the concern today is that ECB easing will discourage the Bank of England from raising interest rates prematurely especially with EUR/GBP trading near 6 year lows. Having broken below 1.64, the next support level for GBP/USD is 1.62, an area that the currency pair broke out from at the end of last year. Concerns about Scottish independence continue to weigh on the currency and with no major economic reports scheduled for release the rest of this week, sterling will most likely remain under pressure. The next 2 major events for the pound will be the minutes from today’s meeting which are scheduled for release on September 17th and the Scottish referendum on September 18th.

JPY: BoJ Express Confidence in Economy

There was very little consistency in the performance of the Japanese Yen today but this had nothing to do with Japanese fundamentals. The Yen traded lower against all of the major currencies with the exception of the euro, British pound and Swiss Franc. European currencies were hit hard today by the ECB’s changes to monetary policy and the sell-off dragged EUR/JPY and CHF/JPY sharply lower. As expected, the Bank of Japan left monetary policy unchanged last night and despite recent deterioration in Japanese data, BoJ Governor Kuroda remained confident that the “virtuous cycle is working in Japan’s economy”, it continues to “exceed potential” and is recovering moderately.” Even as he expresses concern about industrial production and housing investment, he believes that consumer spending remains resilient and risks are higher if the government does not proceed with the next sales tax increase. The BoJ’s lack of concern about the recent loss momentum in the economy indicates that the central bank is in no rush to increase stimulus. For the time being, they remain comfortable with the current level of monetary policy.

Kathy Lien
Managing Director

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