USD: Will Payrolls Miss for Third Straight Month?

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Daily FX Market Roundup 03-06-14

USD: Will Payrolls Miss for Third Straight Month?
EUR: Top 10 Takeaways from ECB Rate Decision
Breakout Move in AUD and NZD
CAD: Sharp Rise in IVEY Points to Stronger Employment
AUD: Short Squeeze Set to Continue
GBP: No Surprises from BoE
Yen Crosses Soar as GPIF Looks to Diversify

USD: Will Payrolls Miss for Third Straight Month?

Although the U.S. dollar traded lower against most of the major currencies today, its solid gains against the Japanese Yen coupled with the rally in stocks and Treasury yields tell us that investors think tomorrow’s U.S. labor market report will be strong. This optimism was sparked by better than expected jobless claims numbers. Claims fell to a 3-month low in the week ending on March 1st and everyone is hoping that fewer firings will translate into stronger higher in February. The Federal Reserve needs tomorrow’s non-farm payrolls report to show a minimum job growth of 115k otherwise their credibility and the validity of taper will come into question. Based on this morning’s comments from Fed President Dudley who is also a voting member of the FOMC this year, the “threshold is pretty high” to change the course of tapering. Similar comments from Janet Yellen last month indicates that she agrees a material change needs to occur in the economic outlook for the Fed to pause tapering. So barring a sub 100k print, the Fed will continue to taper when they meet later this month. Yet with more snowstorms hitting the country in the first 2 weeks of February, we cannot rule out another weak release. In fact, based on other labor market indicators released this month, we have more reasons to believe that NFPs will surprise to the downside than the upside.

Every month we take a look at 8 labor market indicators to help us determine whether NFPs will rise or fall. According to the ISM reports, job growth in the manufacturing and service sectors slowed in the month of February. In fact, the employment component of non-manufacturing ISM contracted at its fastest pace since March 2010. Private payroll provider ADP reported a small increase in corporate payroll growth but that was only after a steep downward revision to the previous month’s report. Consumer confidence was mixed with the University of Michigan reporting an improvement in sentiment and the Conference Board reporting deterioration. The good news is that layoffs declined significantly and continuing claims fell but even with today’s improvement in the weekly jobless claims report, the 4-week moving average is up slightly from last month. Of course, these leading indicators can miss their mark. Two months ago we had a nice rise in the employment component of non-manufacturing ISM and a steep increase in ADP but non-farm payrolls surprised to the downside. Nonetheless we can’t argue with the fact that there are plenty of reasons for payrolls to miss for the third straight month. If job growth exceeds 125k, USD/JPY should extend its gains but if it prints below 100k, USD/JPY will drop back down towards 102. As usual, revisions and the unemployment rate will also influence USD/JPY’s reaction.

Here’s how the leading indicators for NFPs stack up this month:

Non-Farm Payrolls Preview

Arguments for Stronger Payrolls

1. University of Michigan Consumer Sentiment Index Rises
2. Challenger Job Cuts Fall 24.4%
3. Continuing Claims at 2.907 million, down from 2.933 million

Arguments for Weaker Payrolls

4. Employment Component of Non-Manufacturing ISM Drops to Lowest Level Since March 2010
5. ADP Employment Change Rises to 139k from 127k (but major downward revision)
6. Conference Board Consumer Confidence Index Declines
7. Drop in Employment Component of Manufacturing ISM
8. 4 Week Average Jobless Claims Up Slightly

EUR: Top 10 Takeaways from ECB Rate Decision

EUR/USD traded sharply higher this morning on the back of less pessimism from ECB President Draghi and a better than expected U.S. jobless claims report that sent stocks fresh record highs. As expected, the European Central Bank left interest rates unchanged at 0.25%. While Mario Draghi reiterated his pledge to keep rates at present or lower levels for an extended period of time and warned they could take decisive action including activating OMT if needed, these recurrent threats fell on the deaf ears. Instead, investors latched onto the central bank’s upgraded 2014 GDP forecast, Draghi’s observation that money market conditions normalized further and his note that the news in the past 4 weeks has been largely positive. The central bank saw no reason to halt SMP sterilization, which would have been negative for the euro because there is no sign of stress in money markets. They cut their inflation forecasts for 2014 and said the emerging markets and geopolitical uncertainty puts the risk to the economic outlook to the downside but these comments were not surprising. Traders sold euros going into the ECB rate decision and the lack of overly dovish comments today from Draghi triggered a short squeeze in EUR/USD that drove the currency pair to its highest level this year.

Here are our Top 10 Takeaways for the ECB Rate Decision and their implications for the euro

1. ECB Leaves Rates Unchanged at 0.25% – EUR Neutral
2. Reiterates pledge to keep rates at present or lower level for extended period of time – EUR Neutral
3. Repeats warning that ECB stands ready to take decisive action if needed – EUR Neutral
4. ECB Upgrades 2014 GDP growth to 1.2% from 1.1%, expects 1.8% in 2016 – EUR Positive
5. Risks to economic outlook to downside (including EM and geopolitical uncertainty) – – EUR Negative
6. ECB sees news in past 4 weeks largely on positive side – EUR Positive
7. ECB Cuts 2014 Inflation forecast to 1% from 1.1%, expects CPI at 1.7% in Q4 of 2016 – – EUR Negative
8. Money market conditions normalized further – – EUR Positive
9. Saw no reason to halt SMP Sterilization – – EUR Positive
10. EUR rate not a policy target but important for growth and inflation – EUR Neutral

Breakout Move in AUD and NZD

Better than expected economic data and a significant improvement in risk appetite drove the Australian, New Zealand and Canadian dollars sharply higher against the greenback today. AUD/USD enjoyed the strongest gains, with the rally taking the currency pair through 90 and 91 cents. A sharp rise in retail sales and significant improvement in trade activity during the month of January kicked off a rally that gained momentum on short covering. Since the RBA shifted its monetary policy stance from dovish to neutral, we have been warning about the potential for significant short covering and we are finally beginning to see the move. Given the overstretched levels of short positions last week, there’s scope for an extension above 92 cents if tonight’s construction PMI index also surprises to the upside. With no significant economic reports released from New Zealand, NZD benefitted from overall comm dollar demand. The Canadian dollar on the other hand was supported by a sharp rise in building permits and rebound in the Canadian IVEY PMI index. Canada’s housing market is showing signs of life with building permits rising by the strongest amount in 6 months. Yesterday the Bank of Canada said they expect a soft landing in the housing market but if this improvement along with the rise in home prices is sustained, we could be looking at a recovery. Manufacturing activity also accelerated which is great news considering that it already had a sharp jump in January. The employment component of the report rose strongly, a sign that tomorrow’s labor market number from Canada could surprise to the upside, extending the sell-off in USD/CAD.

GBP: No Surprises from BoE

An improvement in risk appetite drove the British pound higher against the U.S. dollar today. As expected, the Bank of England left monetary policy unchanged. Unlike the ECB who delivers a post monetary policy meeting press conference, the U.K. central bank only releases a brief statement outlining their decision. The lack of details minimizes the volatility for the currency, which is generally an ideal outcome for central banks. According to a report from Halifax, the housing market continues to provide underlying support for the economy. House prices rose a whopping 2.4% in the month of February, the strongest pace of growth in nearly 5 years. Halifax mortgage director Stephen Noakes said the sector is benefitting from “the improved economic outlook, unemployment falling faster than expected, improvements in consumer confidence and low interest rates.” However he also feels that “continued pressures on household finances” will constrain the rate of growth going forward. With no major U.K. economic reports scheduled for release tomorrow, sterling will take its cue from NFPs.

Yen Crosses Soar as GPIF Looks to Diversify

All of the Japanese Yen crosses traded sharply higher today with the strongest gains enjoyed by AUD/JPY and NZD/JPY, which climbed to its highest level in 6 years. The market’s demand for risk contributed to the move but the initial gains were driven by an advisory panel’s recommendation that the world’s largest pension fund, Japan’s Government Pension Investment Fund (GPIF) no longer needs to stick to a “domestic-bond-centric portfolio” given the increase in inflation. The panel also encourages the fund to seek slightly higher returns linked to wage growth. In their draft report, they said “Pension payments are correlated with wages, so it’s natural for the target to be an additional return over wage growth. In times of deflation, domestic bond-centered investment was safe and efficient, but with the planned shift to a moderate inflationary environment, there’s no need to focus on local debt anymore. GPIF should become more forward-looking.” The potential increase in risk appetite by the GPIF lifted the Nikkei and in turn USD/JPY. A decision to diversify into foreign bonds in general would be positive for foreign currencies and negative for the Yen.

Kathy Lien
Managing Director

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