Why FX Traders Should Be Skeptical About Payrolls

The September nonfarm payrolls report will finally be released on Tuesday and based on Monday's consolidative price action in the foreign-exchange market, investors are waiting with bated breath for its release. Nonfarm payrolls have always been an important report for the financial markets and currencies in particular but since the Federal Reserve tied monetary policy to the level of unemployment, it has become an even greater focus. Unfortunately with the government shutdown, FX traders should eye every piece of U.S. data released over the next month with skepticism for a number of reasons. First the U.S. government has only been reopened for a few days, so there could be more extrapolation than usual in U.S. data, which means revisions in the next month or two could be particularly large. Secondly, any pickup in hiring in September could be offset by slower job growth in October as the government shutdown delays investment and expansion plans for U.S. corporations. Finally, even if is job growth is very strong, central bank officials will question its sustainability in light of the recent shock to the U.S. economy. Therefore FX traders have every reason to be skeptical of Tuesday's release from the perspective of the data's validity and the potential for impact on Fed policy.

If job growth misses expectations, the dollar could be in even more trouble because October payrolls are expected to be much weaker. Unfortunately there's scope for a downside surprise because service sector activity slowed last month and in turn labor market growth slowed. Consumer confidence was also very weak but that was in a large part due to the fiscal crisis. Even if the data beats expectations, FX traders should not expect the same pomp and circumstance around the release because in 2.5 weeks time, the October payrolls report will be out. We believe that the central bank will keep monetary policy unchanged for the rest of the year because they need to be confident in the data and strength of the labor market recovery before kick starting a major change in policy. Federal Reserve President Evans, who is a voting member of the FOMC this year made it clear in his comments this morning that the central bank is watching incoming data and unsurprisingly, he believes that it will take a few months to sort out the U.S. labor market picture. It will be difficult for the central bank to pull the trigger on tapering asset purchases over the next few months because of the potential distortion in many upcoming economic releases. We won't get a true indication of how well the U.S. economy is holding up until December, when the November reports are released and that timing is too tight in our opinion for the Fed to legitimately pull the trigger on tapering. As this leaves the first move for the Fed in 2014, rates will remain suppressed for the rest of the year, making it difficult for the dollar to rally. So even if the dollar rises on Tuesday's payrolls report, the gains should be limited to another relief rally.

EUR: Potential For Fundamental Support This Week
With no major euro zone or U.S. economic reports released Monday, the euro held steady against the U.S. dollar. Since the beginning of September, we have seen significant gains in the euro that was driven largely by the disappointment in U.S. fiscal policy and its impact on U.S. monetary policy. With a short-term resolution to the first issue, the second factor should become the leading driver of the dollar over the next 2 months but euro fundamentals will also take on increased importance as the focus returns to relative growth and monetary policy. The ECB is not in any position to tighten monetary policy but there's a lot of euro-zone data scheduled for release this week and depending on how they fare, expectations for euro-zone growth could change. The central bank is cautious but there is a lot of hope that the region will benefit from the opportunity for renewed growth in the U.S. and China. We have already seen a significant pickup in investor confidence as measured by the ZEW survey and this week the latest PMI reports and the German IFO survey are scheduled for release. Economists are looking for mild but broad based improvements. If U.S. payrolls surprise to the downside and the PMI reports surprise to the upside, the EUR/USD could rise to fresh 2013 highs this week. Over the next 24 hours, U.S. data will be the primary driver of the EUR/USD flows but by Wednesday that will change with the influx of euro zone economic reports. Switzerland's trade balance is also due for release Tuesday and the country's surplus is expected to have increased significantly in the month of September.

GBP: Near-Term Top?
The British pound traded lower against the euro and U.S. dollar despite an uptick in house prices. According to property website Rightmove, house prices rose 2.8% in the October, erasing last month's 1.5% decline. There are a number of U.K. event risks worth watching this week but they will not come into focus until Wednesday. At the time, the minutes from the most recent Bank of England meeting will be released and we will get a much better sense of how the central bank feels about the recent deterioration in U.K. data. Given that the U.K. experienced three months of positive data surprises, one month of weakness is not going to make the central bank overly concerned in our opinion. Therefore the near term outlook for the GBP/USD hinges on U.S. data. After rising strongly at the end of last week, the currency pair is consolidating below its 2013 high. The strength of U.S. payrolls will determine whether this is a near term top for the pair or a pause before further gains. In the long run, we are still bullish sterling and see any move down to 1.60 as an opportunity to come in at lower levels.

CAD: Weaker Consumer Spending Could Reverse CAD Gains
All three of the commodity currencies lost value against the greenback. The steepest loss was in the New Zealand dollar, followed by the Australian and Canadian dollars. Thankfully the sell-off was modest for all three and represents nothing more than a corrective pullback. Canada was the only country with data on the calendar and according to the report wholesale sales grew at a slower pace in the month of August. Wholesale sales rose 0.5% in the month of August compared to 1.7% the previous month but the headline release was not nearly as weak because of the upward revision to the July report and the larger than expected increase in August. Most importantly however, wholesale sales are a leading indicator for Tuesday's retail sales report. The data suggests that consumer spending growth in Canada slowed which could reverse some of the recent gains in the CAD. Signs of vulnerability in the domestic economy and questions about the cost of the U.S. government shutdown on the U.S. economy will keep the Bank of Canada on hold later this week. We expect USD/CAD to have a delayed reaction to its retail sales report because it will be released at the same time as U.S. nonfarm payrolls.

USD/JPY Lifted By Bond Yields And Nikkei
The nearly 1% rally in the Nikkei and rise in U.S. 10-year bond yields drove the U.S. dollar higher against the Japanese Yen. This move helped to lift all of the Yen crosses. Last night's Japanese economic reports did not have a large impact on stocks but could have contributed to the weakness of the Yen. Japan's trade balance widened in the month of September with exports growing at a slower pace and imports rising but both numbers fell short of expectations. Convenience store sales also fell by a larger amount in September while the all industry activity index grew at a slower pace. Taken together, Japanese data weakened last month. However this slowdown will only keep the Bank of Japan committed to its easy monetary policy stance. Bank of Japan Governor Kuroda reaffirmed the central bank's commitment to achieving 2% inflation and he believes that monetary easing is having an expected impact on the economy which reflects their confidence in current policies.

Kathy Lien, Managing Director of FX Strategy for BK Asset Management.