For Dollar And Yields, It All Comes Down To Payrolls

EUR – Hit Hard by ECB Pledge to Keep Rates Low
EUR/GBP – Seven Straight Days of Losses
CAD – Canadian Employment Numbers Due Friday
AUD – Trade Surplus Turns into Deficit in July
NZD – Oil up, Gold Down
USD/JPY Above 100 for First Time in 6 Weeks

Dollar Rally – It All Comes Down to Payrolls

Today’s hesitant rallies in the U.S. dollar, stocks and Treasury yields tell us that investors are still unsure about whether there is enough reason for the Federal Reserve to taper asset purchases in September. For those who are convinced that they will, there are also lingering concerns that the change will be incremental and underwhelming. These considerations are valid but with each upside surprise in U.S. data, the market’s apprehension slips away. Now that USD/JPY and U.S. 10 year bond yields are trading near key levels, it all comes down to Friday’s non-farm payrolls report. Payrolls probably need to exceed 200k for USD/JPY to see any meaningful rise above 100 and for 10-year bond yields to break 3% and hold those gains. Beating the market’s 180k forecast may not be easy as 200k jobs would be the strongest level of payroll growth since February. At the same time, other reports related to the labor market have been mixed. If payrolls fall short of last month’s 162k increase and/or the unemployment rate rises, USD/JPY and U.S. yields could reject their key levels quickly.

The strongest argument for an increase in non-farm payrolls is the non-manufacturing ISM index. Service sector activity expanded at its fastest pace since January 2006 and more importantly, the employment component of the report rose to its highest level in 6 months. The ISM index increased from 56 to 58.6 in the month of August while jobless claims dropped to 323k from 332k. The jobless claims figures may have been distorted by the Labor Day holiday because data from 3 states had to be estimated, but claims still fell to its second lowest level in 5 years with the less volatile 4-week moving average dropping to its lowest level since October 2007. Continuing claims also declined by 43k to 2.95 million while non-farm productivity was revised up to 2.3% in Q2. Fewer firings have not always translated into stronger hiring, but the rise in the employment component of non-manufacturing ISM index indicates that U.S. companies are hiring. However in the manufacturing sector, job growth slowed slightly despite an uptick in activity. Private sector payrolls dropped to 176k from 196k according to ADP while layoffs jumped 56.5%, a 15 month high according to Challenger Grey & Christmas.

Nonetheless as long as the unemployment rate holds steady at 7.4%, or better yet declines and non-farm payrolls exceed 140k, we still believe that the Federal Reserve on track to taper asset purchases this month. However the weaker the job growth, the less aggressive the reduction in purchases will be.

EUR: Hit Hard by ECB Pledge to Keep Rates Low

The euro fell to six week lows against the U.S. dollar and nearly 4 month lows against sterling after the European Central Bank repeated its pledge to keep interest rates low or lower for an extended period of time. The ECB has been uncomfortable with the rise in market interest rates and this concern is the reason why Mario Draghi is using forward guidance to reduce volatility and to contain the market’s overreaction to the recovery. Draghi may have started his press conference talking about the gradual signs of recovery, but he ended it with a firm warning that the Eurozone is not out of the woods. The best summary of Mario Draghi’s views was his response to a question about more rate cuts – he said the economy is too weak to exclude a discussion about lower interest rates and he doesn’t exclude the possibility of easing again if market interest rates move in an unsatisfactory way. In fact, he even said explicitly that “we have a downward bias on rates.” Inflation in general is subdued even though the central bank raised its 2013 GDP forecast and this lack of price pressure allows the central bank to keep monetary policy easy. More specifically, Draghi feels that while confidence indicators confirm that growth is improving, the risks to their outlook remain to the downside. The ECB raised its 2013 GDP forecast to -0.4% from -0.6% but lowered next year’s forecast to 1.0% from 1.1%. Monetary and credit dynamics remain weak and growth could fall short of their projections if commodity prices continue to rise, global demand softens, there is slow implementation of structural reforms and geopolitical tensions escalate. The main takeaway from today’s meeting is that the ECB doesn’t want to be overly enthusiastic about the initial signs of life in the economy and with market rates headed higher, they are worried that higher borrowing costs could constrain the recovery. The ECB’s commitment to low interest rates should keep the EUR/USD under pressure as the Federal Reserve prepares to taper. The 38.2% Fibonacci retracement of the rally that took euro from its 2012 low to 2013 high is near term support for the currency pair and if this level is broken, the sell-off could extend to 1.30.

EUR/GBP – Seven Straight Days of Losses

While the British pound traded slightly lower against the U.S. dollar today, the more interesting price action for the currency was against the euro. EUR/GBP dropped for the seventh consecutive trading day to its lowest level in nearly 4 months. Widespread improvements in U.K. data contrast sharply with mixed economic reports from the Eurozone. German factory orders for example fell 2.7% in the month July, which is a sign of weaker manufacturing conditions. Earlier this week, we learned that manufacturing activity in the U.K. expanded at the fastest rate in 2.5 years. The Bank of England left monetary policy unchanged today and unlike the first meeting where a detailed statement was released, this month’s was short and sweet. This is the second month in a row in which the statement contained no details, suggesting that Carney is reverting back to the central bank’s previous procedures. We will have to wait another 2 weeks to see if MPC members were encouraged by the recent improvements in data. Industrial production and the trade balance are scheduled for release tomorrow. Based on the sharp rise in the PMI manufacturing index, we have reasons to believe that this these reports will support a further rally in sterling.

CAD – Canadian Employment Numbers Due Friday

The Canadian dollar continued to consolidate against the greenback while the Australian and New Zealand dollars gave back part of yesterday’s gains. Canadian employment numbers are scheduled for release tomorrow at the same time as non-farm payrolls, which can lead to unusual volatility for USD/CAD. In July, Canada lost 39,400 jobs and last month, it is expected to have recovered 20k jobs. Unless job growth exceeds 40k, the data will confirm that the recovery in Canada is losing momentum and will explain why the Bank of Canada adopted a cautious attitude yesterday, warning about the risks of emerging market volatility, global uncertainty and slightly less momentum in the U.S. recovery. Yet unless Canada reports a third month of job losses, the rally in USD/CAD could still be capped at 1.06. Meanwhile the pullback in the Australian dollar can be partially attributed to the deterioration in trade. The country’s trade surplus turned into a deficit in the month of July due to a 4% increase in imports, exports were flat. Regional economists don’t seem to be overly concerned about the downside surprise because resource export volumes are expected to recover in the coming months. No economic data was released from New Zealand and nothing of consequence is expected from either country over the next 24 hours.

USD/JPY Above 100 for First Time in 6 Weeks

For the first time in 6 weeks, USD/JPY is trading above 100 but unfortunately the break above this key level has been weak, which means that in Asia and Europe, USD/JPY could drop below 100. At this stage, the sustainability of the USD/JPY rally hinges upon Friday’s U.S. payrolls report. If job growth exceeds 200k, USD/JPY will be able to hold onto its gains but if it falls short of last month’s rise, the currency pair could slip back below the round the number. The breakout in USD/JPY was triggered by the promise of additional stimulus from the Bank of Japan. The BoJ left monetary policy unchanged last night but Governor Kuroda said the central bank could offset any slowdown in growth caused by a higher consumption with easier monetary policy. According to our colleague Boris Schlossberg who wrote about Kuroda’s announcement extensively, “It appears that Japanese policy makers are coming to the conclusion that the national sales tax hike to 8% from the current level of 5% will indeed take effect. Officially, the Japanese government noted that the final decision will be announced by PM Abe at the start of October, but Mr. Kuroda’s remarks left no doubt as to where he stood. The BOJ chief noted that markets needed to see some fiscal discipline and would lose trust in the Japanese government if the sales tax plans were delayed. It is clear that Japanese monetary officials are afraid that an expansionary monetary policy without the concomitant fiscal tightening could wreak havoc in the JGB market, but by arguing for the sales tax now, they risk the prospect of snuffing out the country’s nascent and fragile economic recovery. Although economic activity has definitely improved with unemployment at 5 year low and capital expenditure turning positive, final demand remains relatively weak and any increase in taxes could have serious dampening impact on consumer spending.”