What USD Traders Can Expect from Non-Farm Payrolls

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Daily FX Market Roundup 10-04-12

What USD Traders Can Expect from Non-Farm Payrolls
ECB Draghi Comments Send EUR Sharply Higher
GBP: Weaker Data Builds Case for BoE Easing
CAD: Manufacturing Activity Slows for Second Straight Month
AUD: Consumer Spending Continues to Weaken
NZD: Oil Prices Up 3.5%, Gold Unchanged
JPY: BoJ to Leave Policy Unchanged

What USD Traders Can Expect from Non-Farm Payrolls

The U.S. dollar traded higher against all of the major currencies thanks to the improvement in risk appetite. While it can be said that the prospect of better than expected labor market numbers drove investors out of safe haven currencies, this is not completely true because otherwise the dollar would have also moved higher against the Japanese Yen. Friday’s non-farm payrolls report will determine whether the rally in risk continues or fades and judging from the leading indicators for NFPs, it will be a tough call. According to a survey conducted by Bloomberg, the current consensus forecast is for payrolls to rise by 115k. This forecast represents an increase in job growth from August, when payrolls rose by only 96k.

Stronger job growth will help the U.S. dollar recover against the Japanese Yen but may not help the greenback’s performance beyond an initial knee jerk rally. We have seen a good NFP number lift high beta currencies at the expense of the dollar on countless occasions and on a day after the market has responded positively to comments from ECB President Draghi, the chance of a EUR/USD rally on a strong non-farm payrolls is even greater. In our opinion, job growth needs to exceed 125k to lift the dollar and risk appetite. Anything between 95k and 125k will not have much impact on the greenback. Should payrolls rise less than 95k however, the dollar will most likely weaken against the Japanese Yen and strengthen against other currencies as risk aversion returns.

Non-farm payrolls always triggers some initial volatility in the FX market but as the dust settles, it is important to remember that a strong or weak non-farm payrolls report will not change the Federal Reserve’s monetary policy stance. They’ll still remain dovish if payrolls beat expectations and will grow even more so if it falls short of forecasts. The minutes from the most recent FOMC meeting were released today and all but 1 member of the monetary policy committee voted in favor of Quantitative Easing. Outside of that, there really wasn’t anything new in the FOMC minutes. The Fed made a bold move last month and now its time to wait and see how much impact QE will have on the U.S. economy.

Here’s how the leading indicators for non-farm payrolls stack up this month. While there are more arguments in favor of stronger payrolls, the ones that point to weaker payroll growth tends to be more accurate forecasters of NFPs.

Arguments for Stronger Payrolls

1. Conference Board Consumer Confidence Index Hits 7 Month High
2. University of Michigan Index Rises from 74.3 to 78.3
3. Continuing Claims Falls to 3.28 million
4. Employment Component of ISM Manufacturing Increases
5. Layoffs Drop 70% according to Challenger Grey & Christmas

Arguments for Weaker Payrolls

1. Employment Component of ISM Non-Manufacturing Falls Sharply
2. 4 Week Moving Average of Jobless Claims at 375k in Sept vs. 371k
3. ADP Private Sector Payrolls Drops to 162k from 189k

ECB Draghi Comments Send EUR Sharply Higher

The euro broke above 1.30 following comments from ECB President Draghi. The European Central Bank left interest rates unchanged but investors were encouraged by Draghi’s steadfast defense of the euro and OMT, reassurance of significant progress in Spain and Portugal, and assessment that inflation is higher than expected. Do not be mistaken, the ECB is still very dovish but going into the monetary policy meeting, a small subset of investors and economists expected a rate cut but Draghi made it clear that they did not even discuss this possibility. It shouldn’t surprise anyone that Mario Draghi had nothing new to say in today’s monetary policy meeting. Having only announced Outright Monetary Transactions (OMT) last month, the ECB is in no rush to ease again and Draghi made it very clear that a rate cut is not even on the table. The ECB President chose instead to spend the majority of his time defending OMT, which he says is a “fully effective backstop.” In other words, the ECB believes all they need right now to properly contain sovereign risk is OMT. However we all know that OMT cannot be activated until all the conditions are in place, which includes a formal request for help from Spain or Portugal. It also sounded like Draghi tried to sweet talk Spain and Portugal into taping the central bank. The ECB President said the “conditions don’t necessarily need to be punitive” and the amount of measures passed by Spain are remarkable. In the same breath, he added that Portugal is an example of the significant progress that can be made. One of the main reasons why Spain and Portugal have been hesitant about seeking aid is the fear that they will be asked to implement more restrictive austerity programs and the ECB is trying to tell Spain and Italy today that may not be the case – which we find hard to believe. Nonetheless, their subtle coaxing has been received positively by the market and taken the focus off of the central bank’s concerns about the outlook for the Eurozone economy. Mario Draghi began his press conference talking about how the euro area economy is expected to remain weak in the near term and will only recovery gradually. Disappointing economic data and heightened uncertainty leaves the risks to the downside. Inflation risks are broadly balanced. At the end of the day, regardless of ECB President’s Draghi’s attempt to defend OMT, it is clear that this program has failed to remove sovereign risk and generate momentum in the markets. If financial market conditions deteriorate, the European Central Bank still has more tools at their disposal. For example, the ECB could cut interest rates or introduce another round of Long Term Refinancing Options. Neither of these measures are needed right now but if bond yields in Europe rise again the central bank could reach into their toolbox.

GBP: Weaker Data Builds Case for BoE Easing

As expected, the Bank of England left its asset purchase program and interest rates unchanged. Recent disappointments in economic data raise concern about the pace of growth in the U.K. This week we learned that manufacturing and service sector activity slowed in the month of September and according to a report from Halifax, house prices continued to decline last month. One of the consistent trends that we have been seeing is weakness in the housing market and so far, banks are slow to take advantage of the BoE’s Funding for Lending Scheme. The outlook for the U.K. economy is grim and for this reason we believe that the central bank will need to ease again. When the minutes are released from today’s monetary policy meeting, we expect to see growing concerns about the economy and a hearty debate on the need to increase stimulus. If true, investors will start to price in the possibility of more QE in November. No U.K. economic reports are due for release on Friday, leaving the pound to trade on the market’s reaction to the U.S. non-farm payrolls report.

CAD: Manufacturing Activity Slows for Second Straight Month

Thanks to the improvement in risk appetite and rally in equities, the Canadian, Australian and New Zealand dollars shrugged off weaker economic data to trade higher against the greenback. Manufacturing activity in Canada slowed in the month of September with the IVEY PMI index dropping to 60.5 from 62.5. While the contraction was less than anticipated, this is the second straight month of slower manufacturing activity. Compared to the rest of world however, a 60 PMI reading is very good. Bank of Canada Senior Deputy Governor Macklem said business investment has been solid which reinforces the central bank’s hawkish bias. Canadian employment numbers are due for release tomorrow and the steep drop in the employment components of IVEY PMI points to softer job growth. Meanwhile another round of weaker Australian data weighed on the Aussie. While building approvals jumped 6.4%, retail sales grew a mere 0.2% in the month of August. Slower consumer spending validates the central bank’s decision to ease this week. According to our colleague Boris Schlossberg, consumers spent “1.5% less on household goods while demand at cafes and restaurants dropped -0.9%. However department stores sales surged by 6.9%. Final demand in Australia is clearly slowing amidst concerns over the global economy and a marked decline in exports of iron ore and coal from China. As Australian economic data continues to deteriorate markets are betting that the RBA will lower rates once again with interest rate futures indicating a 75% chance of another 25 basis point cut in the benchmark rate in November.” Australia’s PMI Construction report is due for release this evening.

JPY: BoJ to Leave Policy Unchanged

The Bank of Japan has a monetary policy announcement this evening and having just increased asset purchases last month, there is zero chance that the BoJ will ease again. Yet rapidly deteriorating economic conditions in Japan will eventually necessitate further action from the central bank. The strong Yen has taken a big toll on the Japanese economy with the trade deficit ballooning and industrial production weakening. Exports fell for the third month in a row in August and the territorial dispute between China and Japan could dampen exports even further. While no changes are expected from the BoJ, the central bank will sound dovish and could hint of more changes in monetary policy. The popularity of Prime Minister Noda is also fading quickly and with general elections looming, he will be forced to step up and defend his job. In an attempt to shore up confidence, Noda replaced 10 key Cabinet Ministers this month but it may not be enough. Former Prime Minister Shinzo Abe is now head of the opposition party and he is eyeing Noda’s seat.

Kathy Lien
Managing Director

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