What FX Moves Signal About Trader Expectations

It was a mixed day yesterday for the U.S. dollar, which held steady against the euro and British pound but traded higher against the Japanese yen, Australian, New Zealand and Canadian dollars. The lack of continuation in yesterday’s sell-off and the rebound off intraday lows in U.S equities signal that investors are trying to remain optimistic ahead of Friday’s non-farm payrolls report. If the market took Monday’s sharp decline in the ISM manufacturing index as a sign of wider trouble for the U.S. economy, the dollar would have extended its slide. However with Federal Reserve Presidents singing the praises of the U.S. recovery, investors are holding out hope that the 12 Fed Districts will report more improvements and non-farm payrolls will surprise to the upside.

The focus of the FX market will begin to shift to the labor market later today with the release of ADP Employment Change, non-manufacturing ISM and the Beige Book report. The employment component of service sector ISM has a very strong correlation with non-farm payrolls and will therefore be the number to watch.

Overall, jobless claims have been very low, which suggests that the labor market continues to recover but fewer firings do not always equate to stronger hiring. Yet even FOMC dove Raskin feels there has been much more progress in the economic recovery and her optimism may be reflected in the Beige book. If it does, the dollar could extend its recovery.

FOMC voter George, who is a noted hawk, was a bit more direct. While she didn’t give a speech because she fell ill, a prepared statement was released whereby she called on the Fed to reduce its pace of Quantitative Easing. The supporters for tapering QE are adding up and as long as Friday’s NFP report isn’t terrible, the Fed should be on track to reduce asset purchases this year.

Meanwhile yesterday’s better than expected U.S. trade numbers barely left a dent on the FX market because the trade deficit still increased. The U.S. trade balance dropped to -$40.3B from -$37.1B in the month of April. Despite the wider deficit, exports and imports both ticked higher which is good news because it reflects stronger external and internal demand. In fact, even with the recent rise in the U.S. dollar, exports hit their second highest level ever.

USD/JPY Gravitates Back to 100

For most of the North American trading session yesterday, USD/JPY flirted with the 100 level. The currency pair rose as high as 100.44 but the decline in U.S. stocks drove it back down to the key level. The only piece of noteworthy Japanese data released overnight was labor cash earnings, which rebounded in the month of April by the strongest amount in more than a year. This is certainly good news for Japan, which is continuing to enjoy a gradual recovery. No economic reports are expected over the next 24 hours but that does not mean that it will be a quiet Tokyo session. Recent volatility in the yen has been driven by big moves in the Nikkei and JGBs. Despite the rebound in Japanese stocks overnight, a weak bond auction caused JGB yields to jump overnight. The Bank of Japan is watching the volatility in the equity and bond markets very carefully and if these moves do not settle soon, they could increase the frequency of bonds purchased later this month.

EUR Trapped Between SMAs

With no major Eurozone economic reports released yesterday, the euro ended unchanged against the U.S. dollar. Producer prices dropped 0.2% in the month of April, which is not a big surprise considering that inflationary pressures around the world remain muted. For the ECB, the current inflationary environment is conducive to additional easing and while they have said they are prepared to stimulate the economy further, the bar to do so should be high, especially after the recent upward revisions to PMI.

Final service sector data is scheduled for release today along with Eurozone GDP and retail sales but none of these reports are game changers for the ECB. In other words, they won’t affect the central bank’s tone on Thursday. The comments from ECB member Coeure yesterday summed up the current state of the Eurozone economy best – he said the region is on a slow path to recovery and will return to growth by year-end.

For the time being 1.31 seems to be tough resistance for the EUR/USD which is coincidently trapped between the 100 and 200-day SMA. A breakout is imminent but a big event risk like the ECB meeting or NFP report is needed to drive the currency pair out of its recent consolidation.

AUD – Reverses Gains After RBA

Of all the major currencies, the AUD and NZD have seen the greatest volatility. They were not only the day’s biggest losers yesterday, but have also been its biggest movers over the past few trading days. Don’t expect the volatility to settle anytime soon as we still have Australian PMI services, first quarter GDP and trade numbers scheduled for release.

The data needs to be very good to offset the pessimism created by the Reserve Bank of Australia’s dovish stance. Despite a more than 8% drop in the currency’s value, the RBA said it remains high “considering the decline in export prices that has taken place over the past year and a half.”

They are either not satisfied yet with the depreciation or want to hold onto it as much as possible by not saying anything that could threaten its decline. In the RBA’s monthly policy statement Glenn Stevens said:

At today’s meeting the Board judged that the easier financial conditions now in place will contribute to a strengthening of growth over time, consistent with achieving the inflation target. It decided that the stance of monetary policy remained appropriate for the time being. The Board also judged that the inflation outlook, as currently assessed, may provide some scope for further easing, should that be required to support demand.

As our colleague Boris Schlossberg point out:

The overall tone of the RBA statement put pressure on the Aussie as it suggested that the central remains open to further rate cuts and furthermore continues to pressure the exchange rate lower despite its already substantial decline.

Meanwhile over in Canada, weaker trade conditions were reported yesterday. The country’s deficit rose from C$3 million in March to C$567 million in April. Imports surged to a record high on stronger energy demand while exports experienced their first decline in 5 months. USD/CAD held onto its gains but like U.S. data, Canadian trade numbers had very little impact on the loonie.

GBP – Additional Improvements in Data, Potential for Optimism

Compared to many of the other major currencies, there was very little volatility in the British pound yesterday. Sterling ended the day slightly lower against the U.S. dollar and euro despite better than expected economic data.

After contracting for 6 straight months, the construction sector finally returned to expansion with the PMI index rising to 50.8 from 49.4. According to Markit Economics, increased activity in the housing market is helping to support building activity. This follows a similarly encouraging increase in manufacturing activity last month and if today’s PMI services index also surprises to the upside, the Bank of England will be able to breathe a sigh of relief and rest easy for another month.

While the minutes from the last central bank meeting showed policymakers still worried about the outlook for the UK economy, given the latest economic reports, they will be in no rush to ease when they convene this week. In fact, when the minutes from this meeting are released, we expect there to be a tinge of optimism.