The U.S bond bear can breath a little easier heading into this morning nonfarm payroll number. However, at one point yesterday during the Euro session, it was looking very bleak with U.S. 10’s backing up to its new 2015 high yield at +2.32%. Since April, the heavy selling in U.S Treasury’s came mostly on the back of the rout in Euro bonds. Yes, U.S data has not been great, but the rates are higher this week for reasons that are not directly related to the Fed or the U.S economy.
European government debt markets are usually considered relatively stable with intraday yield moving only a few hundredths of a percentage point a day. In under three week’s, the “trade of a life time” saw 10-year bund yields rally +75bps from record low yields (+0.05%). Yesterday alone, the yield surged +21 bps to +0.80% (its highest level since last November) before easing back below +0.60% as hedge funds immediately stepped in to pare positions ahead of NFP. Interestingly, Euro peripheral yields saw weaker gains and tightened significantly to bunds as corporate buyers finally appeared. There seems to be no apparent cause for the yesterday’s intraday spike, besides a general lack of liquidity. Because German bund yields act as a benchmark for European financial markets, the violent yield moves have led to a seismic shift in multiple asset classes – DAX down -9% and the EUR up +5% against the dollar since April 10.
EUR loses that loving feeling
The EUR outright has retraced from yesterday’s fresh weekly high of €1.1391, pressured by a number of factor. First and to be expected, there continues to be mixed messages delivered on Greece. There was yet another significant negative headline delivered by EU’s Dijsselbloem who suggested that it’s unlikely a deal can be reached on Monday. The ultimate deadline for the country is the end of June when the latest rescue plans ends – nevertheless, this deadline is moot if the country runs out of cash and next Tuesday there is a small matter of +€750m owed to the IMF.
Second, event risk, many investor’s were content to pare positions and some even cashed in USD and GBP short profits, sending the single unit sub-€1.1250 and €0.7400 in the event that that NFP was going to trump this week’s ADP return and that the U.K general election results could provide a positive surprise. With PM Cameron posting a very strong showing offers continuity for investors (Conservatives looks poised to possibly win an outright majority in a stunning victory). The expectations of a hung parliament would have lead to days or week’s of political bargaining, is being priced out and has given sterling fresh legs for now £1.5460. Nevertheless, questions over Scotland and Europe will eventually return and haunt the pound, but that’s for another day.
What to expect from NFP?
Investors have been trying to avoid taking any lopsided positions ahead of this morning’s jobs report. Yesterday’s U.S weekly claims were strong enough to keep alive some investors expectations for upbeat numbers in this morning’s NFP report. The weekly unemployment claims for the week ended May 1 came out at +265k (+280e), lifting the greenback and sending the pair to fresh intraday lows around €1.1200.
The massive position adjustments this week certainly suit a positive dollar reaction to NFP (+223,000 +5.4% unemployment expected). If the report meets expectations, the Fed should be happy to see the U.S economy getting back on track after a disappointing Q1. It would solidify market expectations that rate hikes are on the cards for later this year. Fixed income/futures are backing a September hike and any variations above or below jobs consensus would obviously shift expectations around that date.
This week’s violent price action across the board, has managed to clear out most of the weaker dollar long positions, despite higher U.S. rates prevailing, with rate divergence being the premise for initiating these long dollar positions in the first place. The USD bulls will be anticipating yields to be driven higher with a stronger headline print. They are expecting U.S. 10s to back up to +2.50% rather quickly. It’s a bit of a stretch from current levels since U.S 10’s have given up nearly -18bp since yesterday. But in the medium term very possible. The USD should be able to find this week’s lost luster against G10 currencies rather quickly given the depth of neutral positions being currently held.
Dollar bears not giving up hope
The dollar naysayer believes support is on their side. Wednesday’s April ADP report does not bode well for a stronger April U.S. jobs print tomorrow. The ADP numbers widely missed expectations (+169,000 versus +205,000 expected) and fell to their lowest level in 18 months. Virtually all the job gains were in small and midsized businesses, and were almost all in the service sector with manufacturing losing a small number of jobs. It marks the second month that headline print was below expectation, which of course signified the U.S. government reported a big miss for March (+126,000). The correlation between the two reports is historically not that strong. However, a miss would suggest there’s some evidence to add to downside risk. The report indicated that falling Crude Oil prices and a stronger dollar is taking a toll on hiring plans. Another soft NFP headline print will take a June hike off the table and certainly leave a September hike very much in doubt.
Investors should be expecting the USD to give back and then some, the traction thats been banked in the past 24-hours. The EUR will be expected to take on the €1.1400 handle sooner than expected. U.S yields should come under pressure, as investors will be expecting ‘lower for longer’ Fed rates. However, this week’s yield moves have been dominated by bunds, and the market consensus believes that trade is not finished yet. Poor market liquidity may increase distress in cases and the US/Bund spread trade remains vulnerable.
