NFP Preview: Will FX Traders Look Beyond Sandy Impact?

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Daily FX Market Roundup 12-06-12

NFP Preview: Will FX Traders Look Beyond Sandy Impact?
EUR Crushed by ECB Draghi Comments
GBP: Hit by Weak Trade Numbers, No Change from BoE
CAD: Risk of Downside Surprise Employment Report
AUD: Job Growth Exceeds Expectations
NZD: Extends Post RBNZ Gains
USD/JPY Breakout Opportunities

NFP Preview: Will FX Traders Look Beyond Sandy Impact?

The U.S. Non-farm payrolls report is one of, if not the most important pieces of economic data on the FX calendar but NFPs does not always have a major or lasting impact on the U.S. dollar, especially in this low volatility environment. Last month for example, USD/JPY rose less than 50 pips despite an exceptionally strong non-farm payrolls report. More than 170K jobs were created in October compared to a forecast of 122K. This month, NFPs are expected to fall sharply and grow by a mere 85K. In any other environment, such a sharp pullback in job growth would have weighed heavily on the U.S. dollar and trigger broad based risk aversion but everyone realizes that the effects of Hurricane Sandy will distort this month’s report. So the question is whether FX traders will look beyond Sandy’s impact. Based on the labor market reports that we normally track, the arguments stack heavily in favor of weaker job growth.
Hurricane Sandy was the largest storm ever to come out of the Atlantic Ocean that left 8 million homes and businesses without power for days. To this day, there are still businesses in the financial district of Manhattan struggling to survive without phone or internet. Therefore it should be no surprise that Sandy caused a notable disruption in the U.S. economy and the labor market in the month of November.

However with jobless claims falling to 370K this week and the retail sector reporting strong holiday shopping sales, investors may look beyond a weak report. If non-farm payrolls rise by less than 50K, that would be a different story because it would only be a third of last month’s gains but if it rises between 75K-100K, there may only be a limited reaction in the FX market. If it exceeds 100K, USD/JPY may rally in relief but once again, the gains may be limited because stronger payrolls won’t stop the Fed from announcing additional asset purchases next week to replace the stimulus provided by Operation Twist, which expires at the end of the year. Of course is payrolls rise by 200K or more, the dollar will soar but its unlikely.

Here’s how the leading indicators for non-farm payrolls stack up this month:

Arguments for Stronger Payrolls

1. University of Michigan reports steady consumer confidence
2. Conference Board reports stronger consumer confidence
3. Continuing Claims drop to 3.205M from 3.267M

Arguments for Weaker Payrolls

1. ADP Employment Change 118K vs. 157K
2. Challenger Grey & Christmas reports 34.4% increase in job cuts
3. Jobless Claims 4 Week moving average rises to 408K from 372K
4. Employment Component of ISM-Non Mfg drops to 50.3 from 54.9
5. Employment Component of ISM-Non Mfg drops to 48.4 from 52.1

EUR Crushed by ECB Draghi Comments

With ECB President Draghi delivering his final press conference of the year, European monetary policy was the main focus this morning. Based on the sell-off in EUR/USD, it is clear that investors didn’t like what Draghi had to say. Interest rates were left unchanged at 0.75% but the euro sold off because the European Central Bank downgraded their 2012 and 2013 growth forecasts along with next year’s inflation estimates and warned that the risks are to the downside. The German stock market, which is trading at its highest level in 4 years is performing well but like all other central banks who met this week, Draghi said the U.S. Fiscal Cliff poses an unknown risk. His grim forecast for economic weakness into next year and his admission that the central bank had a “wide discussion” on interest rates drove EUR/USD sharply lower even though the final decision was to leave rates unchanged. While the ECB did not alter monetary policy, their decision to continue the full allotment of their main refinancing operation at a fixed rate and their downgraded GDP and Inflation forecasts was enough to remind investors that even with the recent stability in European assets, ECB monetary policy is extremely accommodative. There is light at the end of the tunnel however because Draghi believes that we should see the start of a recovery in the second half of 2013. A lot can happen between now and then which is why investors ignored this forecast as the Fiscal Cliff or greater austerity in the Eurozone may throw the projections off course. In the near term, we know that the ECB is still very concerned about the outlook for the Eurozone economy and will continue to practice easy monetary policy. While we don’t think ECB President Draghi has completely killed the rally in EUR/USD, the currency pair has had a very nice run over the past few weeks and a correction is not unexpected. Meanwhile the Swiss Franc recovered some of its recent losses despite a higher unemployment rate and decline in consumer prices in the month of November.

GBP: Hit by Weak Trade Numbers, No Change from BoE

The British pound sold off against the U.S. dollar and the weakness had nothing to do with weak trade numbers or the Bank of England’s monetary policy announcement because the move lower did not occur until 10am NY Time. Instead, the sterling’s gains against the euro confirm that euro weakness drove all European currencies down. As expected, the Bank of England left monetary policy unchanged with interest rates at 0.5% and an asset purchase target of 375B. We actually found it interesting that sterling did not react to the sharp deterioration in the trade balance. The deficit was expected to widen only slightly from 8.44 billion pounds to 8.65 billion pounds but instead it surged to 9.54 billion. Exports declined 1% while imports increased 2.5%. The export sector has been hit hard by weak demand from the Eurozone. Industrial production numbers are scheduled for release tomorrow and despite the improvement in the PMI manufacturing index, the weaker trade numbers suggests that industrial production may not rebound as much as economists hope for in the month of October.

CAD: Risk of Downside Surprise Employment Report

The Australian and New Zealand dollars ended the day higher against the greenback thanks to solid labor market numbers out of Australia and the Reserve Bank of New Zealand’s comfortably neutral monetary policy stance. Earlier this week Australia’s central bank cut interest rates by 25bp after a series of weaker economic reports but since then we have seen more upside than downside surprises in Australian data. According to our colleague Boris Schlossberg, “Australia generated 13.9K new jobs in November versus forecasts of flat growth as the unemployment rate declined to 5.2% from 5.4% in October. This was the second month in a row that labor data has beaten market expectations suggesting that underlying trend in the Australian economy remains positive. However, the headline numbers may have skewed the results to the upside limiting the impact of the data on investor sentiment. All of the job gains were due to part-time rather than full time employment, with full time jobs actually declining by 4,200 in the past month. Furthermore, the participation declined to 65.1 from 65.2 the month prior thus creating the drop in the unemployment rate. The Canadian dollar ended the day unchanged despite a significantly weaker IVEY PMI report. Manufacturing activity contracted at its fastest pace since January 2011. This fourth consecutive monthly decline reflects the strain that the strong currency is having on the economy and puts to question the hawkish bias of the central bank. Employment numbers are due for release tomorrow and given the market’s lofty expectations, there’s a risk to the downside especially considering that the employment component of the IVEY PMI report declined in the month of November.

USD/JPY Breakout Opportunities

It has been an extremely quiet week in Japan with no major economic data on the calendar and it doesn’t say much when tonight’s leading and coincident indices are the most important pieces of data. Leading indicators are expected to increase slightly but the coincident index should decline. The Japanese Yen traded higher against all of the major currencies with the exception of the Australian and New Zealand dollars. The strong rally in AUD and NZD set the performance of AUD/JPY and NZD/JPY apart from other pairs. USDJPY continued to trade between 81.69 and 82.52. Friday’s non-farm payrolls report has the power to break the pair out of its range but we don’t think its is likely because the market expects an unusually distorted NFP report. As a result, the most likely culprit for a breakout should be the lead up to the December 16th General Election. Most analysts see shorting Yen as one of the most attractive trades of 2013 and a large part of their forecast hinges on the LDP and Shinzo Abe coming into power.

Kathy Lien
Managing Director

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