Will Nonfarm Payrolls Save Or Kill The Dollar?

Will Nonfarm Payrolls Save Or Kill The Dollar?

The big story Thursday in the financial markets was the sell-off in the U.S. dollar. The greenback fell quickly and aggressively against all of the major currencies right around the European close and held onto its losses to end the day down 2% against the Japanese Yen and more than 1% against the euro, British pound and Swiss Franc. There were a few different factors behind the sell-off in the greenback. The dollar initially traded lower on the optimistic comments from ECB President Draghi but those losses were contained to the EUR/USD. USD/JPY did not see any losses until 90 minutes before the European close at 12pm NY Time and only when it started to break down did the dollar collapse against all of the major currencies.

We believe that the sell-off was triggered by concerns for Friday’s nonfarm payrolls report. European traders cut their positions before the close and U.S. traders joined the selling as stops were triggered in USD/JPY. By 1pm NY Time, the moves settled and the major currency pairs remained confined in tight ranges into the U.S. close. Investors are growing weary of the outlook for the U.S. and global economy and skeptical of the possibility of Fed tapering this year. While we still believe that the U.S. central bank plans to reduce asset purchases in September, their decision hinges in large part on Friday’s release.

Economists are looking for 165K jobs to be created, the same pace of growth as the previous month. The leading indicators for nonfarm payrolls are mixed which is why the chance of a miss is just as high as a surprise though we lean towards a weaker outcome that could extend the losses for the U.S. dollar. Jobless claims in general have been low and confidence strong. This morning, Challenger Grey & Christmas also reported a 41.2% decline in job cuts. However U.S. companies added fewer workers to their payrolls according to ADP and most importantly, job growth stagnated last month according to the ISM services report. The employment component of ISM is one of our favorite leading indicators for payrolls and the big decline suggests that payrolls could be in the tens of thousands instead of in excess of 150K.

The sell-off in the dollar suggests that some traders may have already priced in a weaker release but we think there is still room for a downside surprise and further dollar weakness. However if payrolls surprise to the upside and print at 175K or better, all of the liquidation of dollar long positions that we saw Thursday, particularly in USD/JPY could be reversed quickly and aggressively, with the pair potentially trading back to 98 in a blink of an eye.

Euro Bursts Higher As ECB Talks Recovery

The euro soared to a two-month high on the back of dollar weakness and talk of recovery by the ECB. While the European Central Bank left interest rates unchanged at 0.50%, slightly more optimism from Mario Draghi was enough to trigger a strong rally in the euro. Draghi spent a bit 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 Thursday 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. Part of the reason is because even though the ECB cut their growth and inflation forecasts this year, they raised their GDP forecast for 2014, reflecting their expectations for stronger growth next year. They now expect the economy to contract by -0.6% in 2013 versus a prior mid range forecast of -0.4%. GDP growth for 2014 is now expected to reach 1.1%, up from a prior forecast of 1.0%. The risks to their outlook remains to the downside because of structural reforms but exports along with accommodative monetary policy are expected to be the driver of recovery. Inflation risks are broadly balanced but CPI is now expected at 1.4% this year versus 1.6% because of the volatility in oil prices. 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: BoE King Leaves Policy Unchanged At Final Meeting

The British Pound extended its gains against the euro and U.S. dollar. As expected, Mervyn King left monetary policy unchanged at his last meeting as central bank governor. Many of the members said that the effects of the previous asset purchases are still coming to play and those effects plus the recent Funding for Lending Scheme should continue to bolster economic growth. Although King is leaving his post as the economy is picking up, he says growth is not as fast as he would like it to be. It will now become Mark Carney’s job to keep this pace of growth sustained. According to the latest economic report, UK house prices strengthened for the fourth month in May. Prices were up 0.4%, which was higher than the expected growth rate of 0.3%. Haliflax’s economist Martin Ellis says, “Despite these recent signs of improvement in the housing market, the subdued economic background and the accompanying weak income growth continue to be a significant constraint on housing demand and activity.” The country’s trade balance is scheduled for release Friday. Given the uptick in manufacturing activity, we expect the trade deficit to narrow, which could compound the gains for the GBP/USD.

CAD Soars But Watch Out For Weak Employment Numbers

The Australian, New Zealand and Canadian dollars rebounded sharply Thursday on the heels of dollar weakness. The AUD/USD, which had fallen below 95 cents overnight is now trading back above 96 cents. There’s definitely been no shortage of volatility for the commodity currencies. Australia’s trade balance missed expectations significantly but when taking the revision to the previous month’s report into consideration, the data wasn’t nearly as bad. Still exports declined 1%, which feeds into the dovish bias of the Reserve Bank. The rally in Canadian dollar on the other hand had underlying fundamental support. PMI rose to its highest level in 14 months in May, printing at 63.1 versus expectations of 56.0. Unfortunately we are worried about Friday’s Canadian employment report because the employment component of IVEY PMI plunged last month, pointing to the possibility of slower job growth. Canada is expected to have created a total of 15K jobs, up from 12.5K. If the data surprises to the downside, the Canadian dollar could resume its slide. Meanwhile incoming Bank of Canada Governor Stephen Poloz delivered his first address to lawmakers Thursday and he sounded optimistic. Poloz said, “We are now seeing signs of recovery in some important external markets, notably the United States and Japan, and there is continued growth in emerging-market economies.” A recovery in foreign demand will bolster the nation’s demand of exports and increase confidence of Canada’s exporters. Poloz added that the BOC’s inflation target is “sacrosanct” so he will most likely keep the interest rate at 1% for the rest of the year at minimum. No economic reports were released from New Zealand, leaving the currency to take its cue from the A$.

Big Moves In The Japanese Yen Will Worry The BoJ

Saying that it has been a volatile day for the Japanese Yen is an understatement. USD/JPY dropped almost 3% before settling down approximately 2%. In the midst of this sell-off, USD/JPY took out the 98, 97 and 96 levels. While dollar weakness was the primary driver of the move, there’s no question that the liquidation triggered stops in USD/JPY that accelerated the breakdown. We wouldn’t be surprised if some large funds got shaken out on this move as well considering that the Japanese Yen is more than 5% off its lows. Japanese stocks have fallen close to 17% in the past few weeks and the Yen is up approximately 6%, both of which is bad news for Japan. If stocks don’t recover and the Yen refuses to resume its slide before the BoJ meets next week, the central bank could be forced to take action to calm investors and to reverse these moves. In the meantime, the decline in U.S. bond yields, persistent drop in the Nikkei and the all out lack of Japanese demand for foreign bonds is keeping USD/JPY under pressure. Last week, Japanese investors sold another 1.17 trillion yen worth of foreign bonds, the largest amount since April 2012. Without the Japanese shifting their funds abroad, the impact of BoJ policies will be limited.