FX Wrap: Has The Dollar Finally Bottomed?

It has been an extremely volatile and tough week for the U.S. dollar but the greenback ended on a strong note courtesy of better than expected nonfarm payrolls. Sentiment in the market was so anti dollars that if payrolls missed expectations, the currency would have crashed, breaking through new levels in the process. However crisis was averted with Friday's jobs number. The labor market report had its areas of weakness but the increase in payrolls was enough to halt the slide in the greenback. The sharp reversal candle in USD/JPY and the pullback in the EUR/USD and GBP/USD shows that investors were relieved to see the day's report but the real question that everyone has is whether the dollar has bottomed.

Considering that the nonfarm payrolls report doesn't change the conversation of tapering asset purchases for the Federal Reserve, this is enough reason to believe that the dollar may have bottomed. If next week's retail sales report also surprises to the upside and we think it could given that the stronger spending already been reported by the International Council of Shopping Centers and Johnson Redbook survey, 95 could mark the bottom in USD/JPY. While the unemployment rate ticked higher and wage growth stagnated, nonfarm payrolls beat expectations, rising 175K compared to a forecast of 163K which was good enough to squeeze the dollar higher. The fact that payrolls exceeded 150K was enough for everyone including the Federal Reserve to breathe a sigh of relief. The rise in the unemployment rate from 7.5% to 7.6% is an annoyance as is the stagnation in average hourly earnings and the downward revision to last month's report but the U-6 unemployment rate, the number economists follow more closely actually declined last month, giving the central bank peace of mind. While there could still be some downside momentum, the fact that the U.S. economy is creating more jobs is good news for the greenback.

We start the new week off with a round of Chinese economic reports -- industrial production and retail sales on Sunday. As U.S. retail sales are not scheduled for release until Thursday, the outcome of these Chinese event risks could set the tone for trading at the beginning of the week. Stronger Chinese data will fuel hope for global growth while weaker data will raise renewed concerns.

BoJ Could Halt The Rise In Yen Next Week
What a week it has been for the Japanese Yen! Much to the angst of the Bank of Japan and everyone that has sold yen in 2013, all of the weakness the currency experienced over the past month has now been recovered. Strength in the Yen has driven all of the Yen crosses lower with the sell-off led by AUD/JPY and NZD/JPY, both of which are down more than 8% since their highs on May 22. The losses in USD/JPY weren't modest either and even with Friday's recovery, the Bank of Japan won't be happy with the recent volatility in the Yen and Nikkei. Japanese stocks topped out on the same day as USD/JPY and have now lost more than 17% of its value. The only stability is in JGB yields, which are elevated but have not hit a new high over the past few weeks. At this stage we strongly believe the Bank of Japan will take some action to calm the market and ease the volatility when they meet next week. If they want to be very aggressive, they should increase the frequency of bonds purchased which would show renewed resolve to lift stocks, drive the Yen lower and stimulate the economy. A more moderate option would be for them to signal plans to increase stimulus but fail to take immediate action, hoping that forward guidance alone would be enough to stabilize the Nikkei and USD/JPY. Either way, we would be shocked if the BoJ said or did nothing at all so expect the volatility to continue in the coming week with the greater risk skewed towards central bank action to halt the rise in the Yen.

Can The EUR Breakout Be Sustained?
The euro hit a three-month high against the U.S. dollar this week on the back of optimistic comments from the European Central Bank and the sell-off in the U.S. dollar. Next week should be a quieter one for the currency from the perspective of euro-zone data so unless U.S. retail sales surprises to the upside the EUR/USD should be able to hold onto its breakout above 1.30. We actually don't have much on the euro-zone calendar aside from consumer prices, which is hardly a market moving release. Therefore the optimism from Mario Draghi should carry through into the new week. If you recall, the head of the European Central Bank spent more time this month talking about the improvements in economic data and their expectations for stabilization and a gradual recovery in 2013. However he did not rule out the possibility of negative rates and instead made it clear that this option was discussed along with ABS, LTROs, collateral and credit claims. The main takeaway from the ECB is that all options are still open but their expectations for stabilization reduces the chance for additional stimulus. We have long felt that even though policymakers introduced the idea of negative deposit rates, the bar is high and with ECB officials divided on its efficacy, the euro-zone economy needed to deteriorate significantly for the central bank to resort to this option. Draghi basically ruled out buying asset backed securities by saying that it would take a prolonged time to get a plan function and more importantly, the market has been dead for many years. The central bank also did not address other types of forward guidance and together, these confirm that there is very little urgency right inside the central bank to follow last month's rate cut with additional easing. So while the ECB is keeping monetary policy easy and all of their options open, their brighter outlook means they aren't poised to pull the trigger on additional stimulus anytime soon which was enough for FX traders to buy euros.

GBP: Data Improvements Make Sterling The Shining Star
With back-to-back improvements in UK data, the British pound was one of the week's most resilient currencies. At one stage it traded at a three-month high against the U.S. dollar. This morning's economic reports continued the trend of upside surprises with the country's trade deficit narrowing to -8.2B from -9.1B, the best reading we've seen since January 2013. Unfortunately weakness beneath the headlines raises some concerns. Both exports and imports declined in the month of April and while imports saw the larger decrease (and hence the improvement in trade), this represents a pullback internal and external demand. Exports to Europe were particularly weak, reflecting sluggish growth in one of the U.K.'s most important trading partners. More U.K. economic reports are scheduled for release next week including industrial production and claimant count. We are looking for stronger numbers all around which could make sterling the shining star next week. Unlike other central banks who are battling mixed to weak economic data, consistent improvements in the U.K. economy allows the BoE to breathe easier. When the minutes from this week's central bank meeting is released, we expect an air of optimism within the central bank.

CAD: Strongest Job Growth Ever
While the U.S. nonfarm payrolls report was the day's primary focus, Canada's employment report was the blowout surprise. Canada added 95k jobs last month, the largest amount ever, sending the Canadian dollar sharply higher. To put this figure into perspective it would be akin to 900K jobs created in the U.S. economy if we adjusted for the population. Unlike the U.S., the unemployment rate also declined and the labor participation rate increased. For the Bank of Canada, who has a new central bank governor, the latest employment numbers will keep monetary policy steady and their bias on raising rates. Compared to the rest of the world, Canada's economy is a shining star that will attract demand for the loonie. While the rally in the CAD against the USD is limited, the Canadian dollar hit a two-year high against the Australian dollar on the back of Friday's employment report. The Australian and New Zealand dollars on the other hand extended their slide, adding to a tally of losses this week. The RBNZ meets next week and despite the decline in the NZD against the USD, the currency remains strong against the AUD, which means they won't be happy. The central bank recently admitted that they are very uncomfortable with the strength of the NZD against the AUD and this sentiment could be evident in their monetary policy statement. If the RBNZ reiterates the need for intervention, NZD could extend its slide. No mention of the currency would be very positive for the currency.

Kathy Lien, Managing Director of FX Strategy for BK Asset Management.