By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
- Dollar and Fresh Concerns for Payrolls
- USD/CAD Soars on Weak IVEY
- GBP: No Changes Expected from BoE
- AUD Reverses Lower Despite Stronger Data
- NZD Extends Gains After PBoC Easing
- Enthusiasm for Euros Fade
Dollar and Fresh Concerns for Payrolls
The mixed performance of the US dollar tells us that investors are concerned about Friday’s non-farm payrolls report and rightfully so after Wednesday’s non-manufacturing ISM release. Although service sector activity accelerated in January, the employment component of the report dropped to its lowest level in almost a year. According to ISM Chairman Nieves, there was a lot of strength in the latest report with the exception of the jobs index. He was quick to point out that one month does not make a trend, although it will be important to keep tabs on the index. He said, “February is pivotal in gauging jobs trend.” Between the pullback in the ADP employment change, the drop in the employment component of services ISM and the sharp improvements already seen in recent months, the risk of a non-farm payrolls disappointment on Friday is growing. Economists are already looking for a slowdown in job growth and the sharp improvement in unemployment in December will be difficult to match. Of course, investors anticipate a more muted labor-market report -- but how the dollar trades will hinge entirely on average hourly earnings. If wage growth rebounds like economists anticipate, the dollar can still rise as long as non-farm payrolls exceed 200k and the unemployment rate remains unchanged. The rise in Treasury yields suggest that bond traders are not worried, but USD/JPY may have a very difficult time breaking above 118 in a meaningful way ahead of NFPs.
Off topic, it is also worth mentioning that German 10-year bond yields dropped below Japanese 10-year yields for the first time ever. The following chart shows how this development points to a potential decline in EUR/JPY.
USD/CAD Soars on Weak IVEY
USD/CAD recovered more than half of Tuesday’s losses on the back of shockingly weak manufacturing activity. The IVEY PMI index dropped from 54 in December to 45.4 in January, the lowest level since December 2013. However our readers should not be surprised by the contraction as we had been calling for deterioration in Canadian data for weeks. Oil prices may have stabilized but the economy is slow to experience the benefits and consequences of the recent moves in oil. We are still getting data from December and January, when oil prices dropped as much as 35%. It will be some time before a recovery in oil starts to positively impact the Canadian economy and show up in economic reports. Therefore we expect more weakness in this week’s releases including Thursday’s trade balance and Friday’s employment report -- a trend that will help USD/CAD recover more of its losses. Meanwhile the RBA’s dovish monetary policy bias appears to have overshadowed Tuesday night’s surprise easing from the People’s Bank of China. The move was partially driven by the desire to increase the liquidity ahead of Chinese New Year but clear indications of economic slowdown also encouraged the central bank to make a move. However data from Australia hasn’t been horrible -- Tuesday night we learned that service-sector activity improved in January, which follows the uptick in manufacturing activity reported earlier in the week. Wednesday night’s retail sales report is also expected to show improvement. As for the New Zealand dollar, the increase in dairy prices at Tuesday’s auction continues to lend support to the currency. Tuesday night’s employment numbers were mixed with the employment change rising sharply. The unemployment rate also jumped but primarily because of an increase in participation.
GBP: No Changes Expected from BoE
The British pound traded higher against all of the major currencies, Wednesday, climbing to the top of its month-long trading range versus the U.S. dollar. Stronger-than-expected service-sector activity helped to establish a near-term bottom for GBP/USD. Last week the Bank of England created a lot of confusion for investors by sending out mixed messages on monetary policy. According to the MPC minutes, the decision to leave interest rates unchanged was unanimous with the two policymakers previously calling for a rate hike shifting to neutral. However shortly thereafter, BoE Governor Carney warned that QE could encourage excessive risk taking and MPC member Forbes said rates could rise sooner than expected. Of course, they were not the same two members that changed their views last month, so Carney and Forbes could be simply reiterating their previous bias. Regardless, there’s a contingent within the BoE that still believe rates should rise and their conviction will be hardened by the latest PMI reports. We have now seen evidence of manufacturing-, service- and construction-sector activity improving in January. This sets the U.K. apart from other countries where data is consistently surprising to the upside. It also guarantees that the Bank of England is not going to join the growing contingent of central banks increasing monetary stimulus. As a result, we expect sterling to extend its gains versus the euro, Australian and Canadian dollars and to finally break out of its month-long range against U.S. dollar. It should be only a matter of time before the 1.5270 high is broken. The Bank of England meets Thursday -- since no change in monetary policy is expected, the rate decision should be a nonevent for the currency.
Enthusiasm for Euros Fade
The enthusiasm for euros faded, Wednesday, with reports that the European Central Bank is resisting the short-term bridge financing component of the Greek government’s debt restructuring plan. Getting the ECB to agree to a solution is critical for Greece and while there may be some push back by creditors, we firmly believe the Troika, which includes the ECB, will concede on some terms because it is in everyone’s interest to avoid a Greek default. Just Wednesday morning, the ECB said it would continue to allow Greek banks to access funds through its emergency liquidity assistance program. According to Prime Minister Tsipras, talks with the ECB and European Union have gone well and he is optimistic that a viable agreement will be made. While we are long-term bearish euros, we recognize that when Greece and its creditors reach an agreement (and it will happen), a short squeeze will push EUR/USD upwards, but we will look at it as an opportunity to sell euros at a higher level. Meanwhile euro traders were completely unfazed by Wednesday’s better-than-expected economic reports. Eurozone retail sales rose 0.3% in December versus a forecast of 0% while the PMI Service and Composite indices were revised higher for January. The central bank’s easy monetary policy gives investors a strong reason to overlook these improvements.