Daily FX Market Roundup 07-05-12

FX: ECB, NFP and Beyond
ECB Rate Cuts Kills EUR/USD Rally
GBP: More QE for BoE
CAD: Canada Releasing Employment Numbers on Friday
AUD: Supported by Stronger Data and Chinese Rate Cut
NZD: Hits Record High against EUR
JPY: Quiet Trading, Positive Comments from Japan

FX: ECB, NFP and Beyond

It has certainly been an exciting day in the foreign exchange market thanks to the stimulative actions of central banks around the world. While the European Central Bank and the People’s Bank of China’s decisions to cut interest rates were the biggest news of the day, it is also worth mentioning that the Bank of England increased asset purchases AND that Denmark’s central bank cut its short term certificates of deposits (CD) rate to negative 0.2 percent. This historic step for the central bank illustrates their commitment to fighting further gains in its currency. Throughout Europe’s sovereign debt crisis, investors have turned to the Krone for safety and today’s action by the Danish central bank helped erase the currency’s year to date gains against the euro. The reason why we point this out is to show that central banks around the world took aggressive steps to stimulate their local economies today and eventually this should bode well for the global economy. However, the equity markets were not impressed. Rate cuts are generally positive for equities and the action of 4 central banks today should have driven stocks sharply higher. Yet instead of rallying, the S&P 500 ended the day virtually unchanged from Thursday’s levels. While some could attribute the lack of a rally in U.S. stocks to the lack participation by U.S. traders still on holiday, the German DAX and the French CAC also ended the day lower. Equities did not respond positively to the easing because of the fear that the European and Chinese central banks have instilled on investors. ECB President Draghi sounded extremely pessimistic about the outlook for the Eurozone economy while the PBoC’s surprise rate cut made everyone wonder if the Chinese economy is doing worse than what is indicated in official releases. If so, then we have a lot to be worried about beyond today’s interest rates cuts.

U.S. Non-Farm Payrolls are scheduled for release on Friday and the amount of job growth will determine whether the Federal Reserve eases in August. According to this morning’s leading indicators for non-farm payrolls, there is a good chance that the pace of job growth accelerated in June. Challenger Grey & Christmas reported a 9.4 percent decline in layoffs while ADP reported a nice uptick in private sector payrolls. The ADP report shows that a total of 176k workers were added to U.S. payrolls in the month of June compared to 136k the previous month. Jobless claims also dropped to 374k from 386k in the week of June 30th. According to the non-manufacturing ISM report, job growth in the service sector also grew at a faster pace. However, a deeper look into these reports and others tells us that even if payrolls rebound, the uptick could be marginal. The four-week moving average of jobless claims actually increased this month compared to last month while continuing claims edged higher. The manufacturing sector reported a slower pace of job growth but the change was small and therefore not very important. Confidence on other hand declined significantly in June according to both the University of Michigan and Conference Board reports. While we are still looking for stronger job growth because of the correlation between private sector payrolls and the employment component of manufacturing ISM, we don’t expect payrolls to rise enough to eliminate the possibility of QE3. With this in mind, the dollar could still rise if payrolls exceed 90k and fall if it less than 75k. Of the 82 economists surveyed by Bloomberg, all but 8 expect stronger payroll growth in June. For more on what we expect for Friday’s non-farm payrolls report, please read our NFP Preview.

ECB Rate Cuts Kills EUR/USD Rally

The EUR/USD gave up all of its EU Summit gains after the European Central Bank cut its refinancing rate to a record low of 0.75%. While the decision was largely anticipated, it was nonetheless significant enough to drive the EUR/USD sharply lower because even though ECB President Draghi refused to comment on LTRO3, his extreme pessimism about euro area growth and low expectations for inflation suggests that this won’t be the last dose of monetary stimulus from the ECB this year. Although the EU Summit helped to stabilize the financial markets and made the market environment a little less tense according to Draghi, it did not remove the pressure on growth. The austerity measures that many countries in Europe have committed to will make rising out of recession very difficult without the help of the central bank. The ECB believes that Q2 data will show renewed weakness in the entire Eurozone and the recovery that follows will be gradual. Most importantly, inflation is projected to fall below their 2 percent target in 2013, providing the ECB with the flexibility to cut interest rates without the risk of stoking inflationary pressures. Aside from the 25bp reduction in the refinancing rate, the ECB also voted unanimously to lower its marginal lending rate to 1.50% and its deposit rate to zero. More weakness in European data will build the case for another long term refinancing operation.

GBP: More QE for BoE

Although the British pound ended the North American trading session lower against the U.S. dollar, the catalyst for the sell-off in the GBP/USD was not the Bank of England’s decision to increase asset purchases but rather the ECB’s decision to cut interest rates. When the BoE announced their plan to raise the size of their Quantitative Easing program by GBP50 billion to GBP375 billion, the British pound actually rallied on the news. While the decision was largely expected, the purchases will be spaced out over 4 instead of 3 months, which also means that maximum daily bond purchases under the program will be lower. Monetary policy committee members felt that the economy was performing worse than they had anticipated and with inflation likely to edge lower and economic indicators pointing to even weaker growth in the near term, they felt the need to take steps to strengthen the economy immediately. It is clear that the prospect of lower inflationary pressure in Europe (which will most likely be caused by lower growth) was a big motivation for the decisions made by the BoE and ECB today. With this program set to end right before the November monetary policy meeting, there is room for additional easing if growth does not rebound in the third or fourth quarter.

CAD: Canada Releasing Employment Numbers on Friday

Unlike European currencies that have been hit hard by the easier monetary policy in Europe, the Australian, New Zealand and Canadian dollars benefitted from China’s surprise interest rate cut. All 3 currencies held onto their recent gains against the greenback but the most impressive moves were against the euro with both the AUD and NZD rising to their highest levels ever against the single currency. As the second rate cut in under a month, the People’s Bank of China’s decision raised concerns about the strength of the Chinese economy. We know that the Chinese government has a strong commitment to boost growth and curb the housing market but given recent improvements in the official PMI numbers, no one expected such an aggressive move minutes after the Bank of England rate announcement and an hour before the ECB rate decision. ECB President Draghi said there was no collusion and in this particular case, we actually believe them but the decision and timing by the PBoC only confirms our belief that China is cooking the books and that the economy is doing worse than the numbers suggest. For Australia, the People’s Bank of China’s decision to lower their reserve requirement ratio, cut their deposit rate by 25bp and their lending rate by 31bp is positive and negative for their economy. If the Chinese economy is really in terrible shape, then demand for Australian exports will suffer but even so it is clear that the PBoC is being proactive, which should help the Australian economy in the long run. The AUD/USD is also supported by improvements in Australian data. Retail sales in May were stronger than expected while the country’s trade deficit widened less than expected. Service sector activity also grew at a faster pace. Canadian employment numbers will be released on Friday followed by the IVEY PMI report. Job growth is expected to have slowed after rising strongly in May.

JPY: Quiet Trading, Positive Comments from Japan

The Japanese Yen traded higher against the euro, British pound and Swiss Franc but remained flat against the US, Canadian, Australian, and New Zealand dollars. It was a quiet day for Japan due to the lack of economic data and the Yen was mainly affected by the Bank of England and European Central Bank’s decision to ease monetary policy. Bank of Japan Governor Masaaki Shirakawa in return pledged to pursue the appropriate policy as the bank holds their monetary policy meeting next week. The BoJ lifted the mood for Japan as it noted a rise their investment and employment situation. It also said there was a moderate recovery in many regions with some pausing but general signs of picking up. Japan’s May Leading Index will be released tomorrow but the yen crosses will largely trade on risk appetite in reaction to the non-farm payrolls report.