This week has certainly lived up to expectations. Market moves were always going to be big due to the amount of event risk that investors are being exposed to; however, we have yet to witness the main event: tomorrow’s U.S. nonfarm payrolls (NFP) report.
In the meantime, today’s U.K. general election will have sterling drifting to and fro (£1.5232), at least until the market gets some political clarity. The rest of us are tied to watching equities possibly slump courtesy of comments made by Federal Reserve Chair Janet Yellen yesterday. While responding to a question from International Monetary Fund Director Christine Lagarde at conference in Washington on Wednesday, the Fed chief suggested that this year’s long rally in stocks may have driven prices to high. Global bourses have seen red ever since as investors’ equity longs likely far exceed any positions held in forex or bonds.
German Yields Keep the Euro in Vogue
This month, the core of the market pressure has occurred in both sovereign bonds and FX. Bund and Treasury yields have aggressively backed up in the past fortnight. The German bund continues to selloff rapidly again this morning, the freefall being supported by France’s soft auction of Obligations assimilables du Tresor, or OAT bonds, (10-year debt). The bund 10-Year yield is currently at +0.76% — the highest since before the European Central Bank (ECB) announced its intention to launch a quantitative easing (QE) program last January. Two weeks ago, German 10s hit an all-time low of +0.05%, spurring predictions of zero or even negative yields on Europe’s benchmark bond. The market call for the “greatest short of a lifetime” ignited the spike in bond yields, and a massive bear steepening of the German curve.
U.S government bonds are naturally being pulled down by the bund, but are also under pressure after comments from Yellen who predicted a jump in long-term interest rates once rate normalization begins. U.S. 10s currently yield +2.254%, a fresh two-month high. Higher European yields will always favor the single unit. The deeper the yields back up, the stronger the bid is for the EUR which is putting more pressure on one of the most vulnerable of trades, short EUR/USD (€1.1376) positions. Currently, the pair has extended its gains through last week’s highs and is threatening to head toward strong resistance at €1.1450 before tomorrow’s U.S. jobs report.
ADP Data Does Not Bode Well for NFP
The massive position adjustments this week certainly suit a positive dollar reaction to tomorrow’s NFP (+223,000 +5.4% unemployment expected). Whether we get that is the million-dollar question. The weaker dollar long positions have mostly been cleared out, and the DXY has reversed 50% of its post December 2014 rise. Yet higher U.S. rates prevail, 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.
The dollar naysayer believes support is on their side. Yesterday’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 numbers were below expectation, which of course signified the U.S. government reports a big miss for March (+126,000). The correlation between the two reports is historically not that strong, and has not swayed too many dealers’ opinions for tomorrow’s print. However, a miss would suggest there’s some evidence to add to downside risk. The report indicated that falling oil prices and a stronger dollar is taking a toll on hiring plans.
A Downbeat NFP Will Induce Violent Price Action
Friday’s NFP is becoming a bigger number the lower the dollar goes against its Group of Seven counterparts. All week, dollar bull speculators have been trying to pick a EUR top in this “correction” move, but the massive backup in global yields is burning them.
Bunds have backed up +65 basis points since April 28. Then of course there is Greece. The back and forth in negotiations, some positive, some negative, is also having a material effect on the single unit. Greece continues to hope (beg?) for leeway, but Athens will not waiver on labor and pensions, and exudes confidence that a deal will be done by Monday. Positive rhetoric is also supporting the EUR to a certain extent. At such lofty currency levels, investors are still trying to figure out the most vulnerable side — have the dollar longs been paired enough or are the EUR short squeezes got much further to go? No matter, tomorrow’s price action has the potential to be very violent on the headline release if it’s a miss either way. As expected, investors will be looking to the next material event risk and that is Greece.
