EUR, AUD Tumble Sharply on US Dollar Gains

The record breaking moves in the S&P 500 has drawn investors into US assets and in turn the US dollar. The greenback extended its gains against all of the major currencies on Wednesday with euro and the Australian dollar experiencing the steepest declines. Non-farm payrolls will be released on Friday and ADP is an important barometer of labor market health. According to the private payroll provider, US companies added 428K workers last month, about half the forecasted amount. When the number was initially released investors reacted by selling dollars but the rally resumed quickly as buyers returned.

Even if tomorrow’s non-manufacturing ISM report shows service sector activity slowing and employment gains weakening, the general sentiment in the market is that the rally in stocks signal a more durable recovery that should lead to lower unemployment. While there are a lot of problems with this theory including the possibility of a second wave as schools re-open, sheer optimism is the main reason why investors are buying US stocks and the US dollar. The Federal Reserve’s Beige Book was also released today and according to the report, economic gains were modest. Business contacts had mixed expectations for staffing in the months ahead with manufacturers expecting staff increases and the service sector anticipating the need for reductions. While USD/JPY rose for the third straight day, the pair is largely rangebound ahead of NFP as traders await Friday’s release.

The reversal in euro gained traction with the single currency headed for a test of 1.18 versus the US dollar. There was no rebound in German retail sales in July like economists anticipated and the worry is that the recovery is weaker than initially estimated. Eurozone retail sales are scheduled for release tomorrow and while we are not looking for spending to fall, it could miss expectations. Signs of the Eurozone recovery losing momentum is worrying investors and with the single currency rising to heady levels, there’s a strong sense of profit taking especially after ECB Chief Economist Lane said the euro-dollar exchange rate matters.

Yet the title for worst performing currency today goes to the Australian dollar. Australia’s economy contracted 7% in the second quarter, more than the market’s -5.9% forecast. Quite frankly we had been bracing for double digit declines but it appears that a 7% drop was enough to send A$ tumbling lower. Having hit 1 year highs on Monday, AUD/USD is vulnerable to a deeper correction especially with weaker manufacturing activity, a cautious RBA and rising China-Australian trade tensions.

In contrast, the New Zealand and Canadian dollars ended the day unchanged thanks to stronger data. In New Zealand, terms of trade improved and for Canada, labor productivity doubled in the second quarter, allowing loonie to completely shrug off the 3% decline in oil prices. With that said, the drop in oil should make 1.30 a near term bottom for USD/CAD.

Last but certainly not least, sterling followed euro lower. As we said at the start of the week, there’s very little on the UK calendar but the data that we’ve seen so far has been better with house prices following mortgage approvals higher. Still sterling is taking its cue from the market’s appetite for US dollars so for now, a deeper correction to 1.3150 seems likely.