WHAT USD STRENGTH SAYS ABOUT PAYROLLS
The U.S. dollar traded higher against all of the major currencies ahead of Friday’s non-farm payrolls report. The strength of the dollar reflects the market’s relief that any increase in job losses in February will be reversed in March. There has been a lot of chatter about how the two snowstorms in the Northeast may have caused job losses to explode last month. Based upon the price action in the dollar today, it would be reasonable to assume that forex traders will downplay tomorrow’s non-farm payrolls report. However traders tend to have short term memory which means there could still be a sharp reaction to a surprisingly weak or strong NFP number. The only difference is that the knee jerk reaction could be reversed quickly.
Bullard and Evans’ Comments Reflect Division within the Fed
Part of the dollar’s rally was originally attributed to the initial comments made by St Louis Fed President Bullard who said the expanded monetary base has created medium term inflation risk and the expansion is expected to be persistent which suggests that inflation could also be persistent. However he went to on to predict substantial bank failures this year and said the central bank wants to stay very accommodative because the recovery is in an early stage. Yet Chicago Fed President Evans did not share his concerns. Instead, Evans said the recession appears to be over and therefore policy can’t remain accommodative for long. In particular, “monetary policy cannot be passive” although end of accommodative policy is still “quite a ways away.” The latest comments from Federal Reserve Presidents Bullard and Evans reflect the division within the Fed. Given that Bullard is a voting member and Evans is not, we put more weight on Bullard’s cautious comments.
What to Expect for Non-Farm Payrolls
Meanwhile Friday’s labor market report is not expected to provide any encouragement for supporters of the U.S. recovery because job losses will most likely accelerate. The improvements in the labor market have been uneven and we expect this trend to continue – the only difference is that this time we have Mr. Frosty to blame. Several snowstorms have hammered the Northeast, triggering temporary layoffs in weather sensitive construction and transportation industries. Some non-salaried employees may have also been taken off payrolls for not being able to get to work. Given the possibility of weather related distortions to the report, forex traders may not be all that discouraged by a weak number unless job losses exceed 100k. With an exceptionally wide range of market forecasts, the only thing that we can be assured of is volatility. The most pessimistic analyst on the street is calling for 150K job losses of while the most optimistic is forecasting 30k job growth. The consensus forecast is -63k. Many traders have been appalled that the White House (through Obama’s economic advisor Larry Summers) is attributing a weak labor market to the snowstorms but with the Northeast facing the worst winter in decades, we cannot ignore the fact that weather matters. It may not explain the entire decline but will be contributing factor. The White House is simply preparing the market for what could be a very weak report by telling everyone to look beyond the numbers and to focus on the overall trend. First, let’s get the facts straight - Larry Summers did not have the report on hand when he made his comment but the East Coast is a highly populated area and the 2 big snowstorms crippled the region for days. With this in mind, the most important question is whether a large increase in job losses will matter because what is taken away in February will probably be added back in March. Since long dollar positions are at extreme levels against the euro and British pound, we don’t think that the market will completely ignore the report. Instead, there will probably be a sharp pickup in volatility that will trigger the typically wide two way movement in the dollar that occurs following the NFP release. In other words, the chance of a reversal to the knee jerk price action in the EUR/USD is exceptionally high this month.
EUR/USD SELLS OFF AS TRICHET DISAPPOINTS
The euro fell sharply against the U.S. dollar, erasing all of Wednesday’s gains in the process. Although the European Central Bank announced additional plans to reduce emergency measures including implementing a variable rate on the 6 month tender and auction system for the 3 month tender, traders were not impressed. The ECB did the minimum of what was expected (the 1 month tender remained unchanged) while reducing their inflation forecast and tightening their growth forecasts. With inflation not expected to be a problem, there is little urgency within the ECB to tighten monetary policy. Buyers of euros were also extremely disappointed that ECB President Trichet backed away from any formal support for Greece and even said the IMF would not be appropriate as a “supplier of help” to the Greek economy. As our colleague Boris Schlossberg pointed out “Mr. Trichet’s emphasis on letting Greece work out its fiscal problems within the framework of the European Union cast some doubt on resolution of the Greek conflict and the EUR/USD weakened marginally in the wake of his remarks.” The passiveness of the ECB has completely overshadowed the successfulness of Greece’s 10 year bond auction today which was approximately 3 times oversubscribed. They were hoping to raise EUR5 billion but they received EUR14.5 billion in bids. Spain’s 5 year bond auction was not as successful but the bid to cover ratio was still 1.48. This is reassuring because it indicates that despite the well publicized problems in Greece and Spain, they have still managed to attract demand. The only piece of Eurozone data on the calendar tomorrow is German factory orders and unfortunately this report will not be significant enough to trigger a turnaround in the euro.
GBP/USD: NO DRAMA FROM THE BOE
Like most of the other major currencies, the British pound succumbed to the rally in the U.S. dollar. Yesterday’s recovery in sterling was short lived as the currency reverted to the downtrend that it had become all too familiar with over the past 2 months. The Bank of England left both the size of their Quantitative Easing program and interest rates unchanged. They offered no additional details in their brief statement which basically means that for the time being, the tone of the report remains unchanged. As we said in the ECB and BoE preview published yesterday, the only thing that could prevent a change in the tone of the report is inflation. Not only is consumer prices above their 2 percent inflation target, it is also above levels that require a formal explanation and plan of action be submitted to the Chancellor (3 percent). With service sector activity improving and the weakness in the pound expected to help the manufacturing sector, the BoE has time on its side and could opt to wait another month before formally backing more QE. Yet in the grand scheme of things, the Bank of England is still the most dovish central bank and this label will limit any recovery in the pound. Meanwhile there have been more reports of lower house prices. Last month Nationwide reported 1 percent drop in house prices in February and this morning, Halifax reported a 1.5 percent decline. Producer prices are due for release tomorrow and even though price pressures are expected to rise, the pace of inflation growth should slow.
USD/CAD: LOONIE EXTENDS GAINS DESPITE MIXED DATA
The Canadian dollar continued to rise despite the overall strength of the U.S. dollar, mixed economic data and lower oil prices. Manufacturing activity in Canada accelerated with the IVEY PMI index rising from 50.8 to 51.9, but with a forecast of 56, the improvement was much weaker than economists had anticipated. This was the first rise in 4 months, but the details of the report suggest that job growth has slowed. Building permits also fell 4.9 percent against the market’s 0.8 percent forecast. This was the third consecutive month of fewer permits, a clear sign that the housing market is slowing. The Canadian government also released their budget for 2010-11 and their plan to reduce their deficit. The Canadian dollar failed to react to the budget release due to the lack of surprises (the Canadian government expects a deficit of C$49.2 billion and the smallest increase in spending in more than a decade). There is little to explain the strength of the loonie today other than a continuation of the rally that stemmed from the Bank of Canada’s hawkish comments earlier this week. Meanwhile the Australian dollar sold off against the greenback but the most pronounced weakness was in the New Zealand dollar which fell for the third consecutive trading day. There was no economic data released from New Zealand but the Treasury reported a narrower cash deficit. Income and company tax receipts fell short of forecasts but sales tax receipts were strong thanks to more spending. Australia’s trade balance narrowed in January to the smallest level in 7 months as China continues to buy iron ore and coal.
USD/JPY: BOJ CALLS FOR FISCAL REFORM
USD/JPY was on a tear this morning following the better than expected U.S. jobless claims report. Although the yen sold off against the dollar, its performance against other currencies was mixed. Capital spending fell at a slower pace in the fourth quarter which was encouraging but not significant enough to impact the Yen. According to Bank of Japan board member Noda, keeping very easy monetary conditions is a necessary condition for beating deflation. However he argued that further monetary easing is not the solution to fighting deflation. Instead, the government needs to repair its finances. Prime Minister Hatoyama agreed that there is no question that Japan’s fiscal state is quite severe. Rating agency Standard & Poor’s had previously warned that unless Hatoyama comes up with a plan to reduce the nation’s debt, Japan could lose its AA credit rating, an embarrassment that Hatoyama certainly wants to avoid. The fate of USD/JPY will be determined by the U.S. non-farm payrolls report. If job losses are not huge, USD/JPY stands a chance of extending its gains. Otherwise, more losses are probably in store.
GBP/USD: Currency in Play for Next 24 Hours
The currency in play for the next 24 hours is the GBP/USD. The Producer Price Index will be released from the U.K. at 9:30GMT or 4:30AM EST while the Non-Farm Payrolls report will be released from the U.S. at 13:30GMT or 8:30AM EST. GBP/USD continues to hover within the Sell Zone which we determine using Bollinger Bands. This indicates that the downtrend in the currency pair remains intact. The closest support is at 1.50, which is a psychologically significant level. If the currency pair breaks below that point, there is no major support until the12 month low of 1.4780. However if the GBP/USD manages to recover and breaks above 1.5190, the downtrend would be broken, exposing the currency pair to the possibility of further gains.
