By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
Behind the Post NFP Recovery in the Dollar
Investors sold U.S. dollars aggressively after Friday morning’s abysmal nonfarm payrolls report crushed hopes for an October rate hike by the Federal Reserve. In fact, if there are no revisions next month and payroll growth rises by less than 200k in October and November, a December rate is also off the table. In September, Janet Yellen made it very clear that they want to see further job growth but instead of gaining strength, labor-market activity deteriorated significantly last month. As a result, rate-hike expectations have collapsed with Fed fund futures now pricing in only a 30% chance of tightening before the end of the year compared to 45% chance pre-NFP. So it should be no surprise that the dollar adjusted as well. However by the end of the North American session Friday, the greenback clawed back its losses on the premise that of the large number of Federal Reserve officials scheduled to speak next week, many will continue to throw their support behind a 2015 tightening.
But talk is cheap when data is weak. Only 142k jobs were created in September and the August figures were revised down to 136k from 173k. More importantly, average hourly earnings growth was flat, which was much weaker than the market anticipated and while the unemployment rate remained unchanged, the participation rate dropped to its lowest level in 38 years. In order for the bulls to return to the dollar, we need more than talk from U.S. policymakers. U.S. data needs to surprise positively and in very big ways. Non-manufacturing ISM is the most important U.S. economic report on the calendar next week. The Fed minutes are also scheduled for release and that may have a more significant impact on the dollar.
EUR/USD soared above 1.13 intraday on the back of the weaker U.S. labor-market report before settling back near 1.12.Friday’s price action was driven exclusively by the market’s appetite for U.S. dollars because Eurozone data surprised to the downside. Producer prices came out much weaker than expected with PPI falling for the second month in a row by -0.8%, the largest decline in 7 months. Deflation is not a major concern for ECB officials but the recent trend of inflation reports combined with low commodity prices adds pressure on the central bank to ease. Additional easing is not necessary at this time but these weak reports along with softer data from Germany will keep euro from rallying too much. There are only a handful of Eurozone economic reports scheduled for release next week – none of which are extremely market moving. We have revisions to the PMI Composite, German Industrial Production and the Trade Balance. ECB President Draghi is also scheduled to speak but given that the forum is the Art on Site Inauguration, he may not touch on the economy or monetary policy.
For the first time in 11 trading days, sterling ended the North American session with some decent gains versus the U.S. dollar. We are looking for a further near-term rally in GBP/USD because when the pair turns, the reversal can be strong -- but the sustainability of gains hinges on the Bank of England, which has a monetary-policy announcement next week. While no changes are expected, the BoE now releases the minutes at the same time as its statement and the number of dissenters as well as the overall tone of the central bank could have a big impact on how sterling trades. Last month, only 1 member of the monetary policy committee voted to raise interest rates and the central bank as a whole did not sound overly concerned about global developments or domestic conditions. While they lowered their Q3 growth forecast, they made no mention of the downside surprises in the PMIs and instead said productivity has begun to increase and core inflation may be firming. They believe that domestic demand will help erode spare capacity in the coming year. On balance, their comments suggested that they are still looking to raise rates next year but want to see what the Fed does first.
All 3 of the commodity currencies moved higher Friday but the shallowest gains were in AUD/USD. Next week is a big week for the Australian dollar with PMI services, the trade balance report and a Reserve Bank of Australia monetary policy announcement on the calendar. Given the recent improvement in economic data including Thursday night’s retail sales number and this week’s PMI manufacturing index, the RBA is not expected to lower rates. However the relative weakness in AUD reflects the market’s expectations for continued dovishness from the central bank.
The risk is to the downside for the Japanese yen next week. While the Bank of Japan is not expected to change monetary policy, Japanese data has taken a turn for the worse as the stimulative impact of Abenomics begins to fade. Easing in late October in Q4 remains a possibility for Japan and if the Bank of Japan reinforces that possibility with dovish comments, the yen could extend lower.
USD/CAD, which extended its losses Friday post NFP, is in play next week with the country’s trade balance, IVEY PMI and employment reports reports scheduled for release. Steady job growth is expected and we are looking for the recent stabilization in oil prices prices to encourage an uptick in manufacturing activity. Like AUD and CAD, NZD traded higher Friday on the back of the dollar and a strong rebound in the ANZ Commodity.