Non-Farm Payrolls Preview, Impact on USD

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Daily FX Market Roundup 01-09-14

Non-Farm Payrolls Preview, Impact on USD
ECB – Stronger Forward Guidance is Negative for EUR
GBP: Ignores Stronger Trade Data
USD/CAD Hits 4 Year Highs
AUD: Shrugs Off Stronger Retail Sales, Chinese Trade Next
NZD: Divergence in AU/NZ Building Permits Signals Higher AUD/NZD
JPY: Nikkei Resumes Slide Taking USD/JPY Down With It

Non-Farm Payrolls Preview, Impact on USD

A lot of economic reports were released this week but outside of the Canadian dollar, the movements in currencies have been limited. While central bankers love low volatility environments, foreign exchange traders are frustrated by the lack of big moves. Hopefully that will change with tomorrow’s non-farm payrolls report. Based on the strong intraday recovery seen in stocks, investors are positioning for a healthier release. However the sell-off in the dollar versus the euro and Swiss Franc along with the decline in 10 year Treasury yields suggests that not everyone is convinced that tomorrow’s release will be strong. Trading non-farm payrolls is always tricky because aside from the absolute amount of job growth, revisions and the unemployment rate will also affect the market’s action.

Nonetheless, we have a list of reasons why we believe that non-farm payrolls exceeded 200k for the third month in a row. The estimates from economists range from a low of 100k to a high of 250k and we think that NFPs will print around 210k because as you can see below, there are far more arguments in favor of stronger than weaker payrolls. In fact the only leading indicator that points to a decline in job growth is jobless claims and it did a poor job of tracking NFPs last year.

Arguments for Stronger Payrolls

1. Rise in Employment Component of Non-Manufacturing ISM
2. Rise in Employment Component of Manufacturing ISM
3. Uptick in ADP Employment Change
4. Rise in Conference Board Consumer Confidence Index
5. Share Rise in University of Michigan Consumer Sentiment
6. Smaller drop in Job Cut announcements (Challenger Layoff Report_

Arguments for Weaker Payrolls

1. 4 Week Average of Jobless Claims Rises to 358k from 324k
2. Continuing Claims at 2.86M vs. 2.79M

Potential Impact of Non-Farm Payrolls on the U.S. Dollar

Non-farm payrolls also surprised to the upside last month when payrolls rose 203k versus a forecast of 183k. USD/JPY enjoyed a leisurely 75-pip rally while the EUR/USD did its typical V-shaped move after payrolls. As shown in the chart below, the initial dollar rally drove EUR/USD to a low of 1.3617 but within the next hour, EUR/USD was already trading higher as stocks responded positively to news. Eventually the currency pair ended the day near 1.3700, more than 80 pips off its post NFP lows. If payrolls are beat expectations, we can expect a similar reaction in currencies but if its weak, which would be the larger surprise, the dollar could fall quickly.

ECB – Stronger Forward Guidance is Negative for EUR

The main takeaway from today’s European Central Bank meeting is that low inflation and the volatility in money market rates are becoming a bigger headache for the central bank. While the ECB left interest rates unchanged, the euro sold off when central bank President Draghi said they strengthened their forward guidance. In addition to saying that “interest rates will remain at present or lower levels for an extended period of time,” Draghi warned that they would “act if the inflation outlook worsened” or “money markets tightened.” This enhanced forward guidance leaves the ECB with a slightly more dovish stance which explains why EUR/USD dropped to a fresh 1 month low on the back of Draghi’s comments. However the currency pair bounced off its lows after investors realized that the central bank has grown more serious about dropping interest rates below zero. Draghi said all policy tools are at their disposal and they stand ready to act if needed but right now they are comfortable with the current level of monetary policy. The central bank President spent most of his prepared comments talking about low inflation. He barely acknowledged the momentum in Germany’s economy and simply said incoming data confirms the ECB’s previous assessment and warned that growth risks remain “on the downside.” It seems that Draghi is not impressed by the positive surprises in German data because the rest of region is still growing slowly. He described the economy as weak and said output should recover at a slow pace in 2014 and 2015. With inflation expected to remain low for at least the next 2 years, interest rates will stay at the present or lower level for an extended period. However in order for monetary policy to be eased again, the inflation outlook needs to worsen or money markets need to rise. Some will argue that nothing new came out of today’s ECB press conference because the bar is high for negative rates, but the ECB enhanced its forward guidance which means they are strengthening their dovish bias at a time when the Federal Reserve is hardening its commitment to taper asset purchases. While the EUR/USD recovered intraday, we are still looking for the currency pair to drop to 1.35 in the near term but of course that would hinge in large part on a strong non-farm payrolls report.

GBP: Ignores Stronger Trade Data

The British pound ended the day unchanged against the euro and U.S. dollar. As expected, the Bank of England did not alter monetary policy unchanged and as such, their statement contained very little details. These days, the minutes from the MPC meeting has become more important than the actual rate decision because it is where the discussions and biases of the central bank are revealed. So the more interesting release from the U.K. today was the trade balance. The deficit narrowed to GBP9.4 billion in November from GBP9.7 billion thanks to the 2% increase in exports and 0.8% gain in imports. This simultaneous increase is indicative of a stronger U.K. and global recovery and is one of the main reasons why we expect the U.K. to be one of the best performing countries this year. As growth improves, the Bank of England will have to decide whether it is appropriate to pull forward their plans for tightening. The key is wage growth – if stronger growth leads to higher wages, the central bank may have to act sooner to avoid a spike in price pressures. With the ECB hardening its dovish forward guidance, we are looking for EUR/GBP to fall to 80 cents. Tomorrow’s industrial and manufacturing production reports are likely to show a small increase as manufacturing activity improved in the month of November. It wasn’t until December that growth slowed.

USD/CAD Hits 4 Year Highs

Better than expected U.S. jobless claims drove USD/CAD to a 4 year high and at this stage, there is no major resistance for the pair until 1.10 as long as it holds above the 2010 high of 1.0854. Tomorrow’s Canadian employment report could decide whether USD/CAD breaks 1.09 and gets on its way to 1.10. Job growth is only expected to slow slightly but if it surprises to the downside and the unemployment rate increases, the breakout in USD/CAD could gain momentum, especially if U.S. non-farm payrolls surprise to the upside. Based on the decline in employment component of IVEY PMI, there is a good chance that job growth slowed more than economists expect for the month of December. The drop in housing starts and building permits confirm the challenges that Canada’s economy faces – the housing market is the single biggest risk for the economy this year. The Australian and New Zealand dollars also declined despite better data. Australian retail sales rose 0.7% in November, up from 0.5% the previous month while New Zealand building permits jumped 11.1%, was the strongest pace of growth in 8 months. Australian building permits on the other hand declined. Even with the increase in spending, New Zealand’s economy is still outpacing Australia’s, which is why we believe AUD/NZD is headed for 1.05. For the Antipodean currencies, tonight’s Chinese trade numbers are key. If export growth slows as much as economists expect, we could see further losses in the Aussie.

JPY: Nikkei Resumes Slide Taking USD/JPY Down With It

The Japanese Yen traded higher against all of the major currencies today as the Nikkei resumed its slide. Japan’s stock market erased nearly all of yesterday’s gains and with no Japanese data on the calendar, the sell-off was blamed on profit taking ahead of the U.S. jobs number. Companies like Sony continued to do well after China lifted their ban on console sales but gains in technology stocks failed to offset losses in the broader index. Bank of Japan board member Shirai made an interesting comment today – she said that it may be preferable to take more than 2 years to meet the inflation target in order to keep monetary policy conditions easy for households and businesses. She also said it is still unclear whether the central bank will be able to bring inflation up to 2%. This type f skepticism is not new for Japanese policymakers and confirms that monetary policy will remain easy. We finally have some Japanese data scheduled for release tonight with the Ministry of Finance’s weekly portfolio flow report along with the leading and coincident indexes. The activity reports will most likely show a further improvement in growth while the portfolio data should show increased demand for foreign assets.

Kathy Lien
Managing Director

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