By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
The U.S. dollar climbed to 2-month highs versus the euro and Japanese yen ahead of Friday’s nonfarm payrolls report but without seeing the outcome of NFP, investors are hesitant to take the dollar higher. On Wednesday, Janet Yellen made it clear that the Federal Reserve is ready to raise interest rates if data improves, which makes Friday’s labor-market report even more important. Nonfarm payrolls is one of the most market-moving reports for the dollar and the forex market in general but this month we expect an even larger, more volatile reaction to NFP. If the U.S. economy adds more than 200k jobs, average-hourly earnings increase and the unemployment rate holds steady, the dollar will soar to new monthly highs, paving the way for stronger gains ahead of the December FOMC meeting. All the market wants to see is one strong labor report to validate the Fed’s views. However if job growth falls short of expectations or average-hourly earnings growth stagnate for another month, then the dollar will give up its recent gains and fall sharply against the yen.
Over 92 of the economists surveyed by Bloomberg 96% expect nonfarm payrolls to rise more than the previous month when job growth reached only 142k. Between those forecasts and the recent performance of the U.S. dollar, it is clear that the market is bracing for a strong report. In fact, payrolls are expected to rise by the largest amount in 3 months. We are looking for payrolls to exceed 200k because according to ISM, service-sector employment rose at the second-strongest pace since August 2005. Given the weakness of the last 2 employment reports, the job growth in services should appear in the October and November reports. Every month we look at 8 leading indicators for nonfarm payrolls and although only 5 out of the 8 signal a healthier labor report this month, those 5 are important. Also, the arguments against a strong report can be countered easily as manufacturing jobs are not included in the headline number, the drop in ADP was small and the decline in the consumer confidence index is offset by the rise in the University of Michigan Consumer Sentiment survey.
Arguments Favoring Stronger Payrolls
- Challenger reports 1.3% drop in layoffs
- 4-Week Moving Average of init fall to 262K
- Continuing Claims also Lower
- Employment Component of ISM Non-Manufacturing 2nd Strongest Since Aug 2005
- University of Michigan Sentiment Index Rises in October
Arguments Favoring Weaker Payrolls
- ADP Employment Change Drops to 182K from 190K
- Employment Component of ISM Manufacturing Weakest Since Aug 2009
- Consumer Confidence Index Hits 3 Month Lows
The best way to trade nonfarm payrolls is to wait because unlike other reports where the focus is just on the main release, there are many underlying components and revisions that could affect the market’s reaction. The ensuing move in dollar post-payrolls should last for days or weeks to come.
The biggest story in the forex market Thursday was the sharp decline in the British pound. Sterling dropped like a rock following the Bank of England’s monetary policy announcement. While the BoE’s decision to leave policy unchanged was right in line with expectations, the market had hoped that more than 1 member would have voted for a rate hike but unfortunately McCafferty was the lone dissenter. However it was the Quarterly Inflation Report that really killed the pound. Not only did the central bank express concerns about global growth and the impact of commodity prices on inflation but it also lowered its GDP and inflation forecasts. The recent strength of the pound and its expected outperformance versus the euro when the ECB increases stimulus reduces the need for a rate hike. The BoE even went so far to say that asset purchases would only be unwound when the key rate reaches 2%. Inflation is one of the central bank’s biggest concerns and it expects sterling to affect CPI for the next 2 years. Although BoE Governor Carney said it is “reasonably prudent to think BoE rate will rise in 2016,” the price of action of sterling Thursday indicates that the dovish Quarterly Report caught the market completely off guard. Such a big surprise tends to have continuation and if U.S. nonfarm payrolls are strong enough, GBP/USD could test 1.55.
The euro on the other hand traded marginally higher versus the U.S. dollar. The lackluster bounce was driven primarily by EUR/GBP demand and an exhaustive recovery in the currency. Eurozone data remains weak with German factory orders falling 1.7% in September. Economists had been looking for a 1% bounce. Eurozone retail sales also fell 0.1% against expectations for a 0.2% rise. Thursday’s reports reinforce the ECB’s dovish bias. The central bank lowered its 2016 growth forecast in the latest EC economic report with ECB member Smelt saying there is a risk that inflation expectations could become unanchored. As a result, the degree of policy accommodation will be reexamined at the December meeting according to the central bank. 1.08 is currently the key support level in EUR/USD and whether support gives depends on the outcome of Friday’s U.S. labor-market report.
Canada will also release its employment numbers on Friday. USD/CAD traded higher in anticipation of the report and in reaction to the IVEY PMI report. Not only did manufacturing activity expand at its slowest pace in 3 months but the employment index fell sharply dropping to its lowest level in 7 months. So chances are that Friday’s Canadian employment report will be weak and if that coincides with a strong U.S. report, we could see USD/CAD surge to new 1-month highs above 1.3280.
No economic reports were released from Australia and New Zealand and with gold and copper prices unchanged, AUD trod water versus the USD. NZD/USD on the other hand bounced off the 100-day SMA at 0.6580 after 3 days of sharp selling.