Will Payroll-Driven Rally In Forex Last?

Will Payroll-Driven Rally In Forex Last?

Investors put on their rose-colored glasses, Friday, and drove currencies and equities sharply higher on the back of stronger job growth in the month of April. At a time when other central banks like the ECB and BoJ are kick starting a new round of easing, the better than expected labor market report will keep the Fed comfortably on hold. The question now is whether the payroll driven rally in FX (and stocks) will last. With far less important data on the calendar next week, we think investors will remain optimistic. The EUR/USD will most likely hold 1.30 and USD/JPY could test 100 but the lack of market moving euro-zone and U.S. data means 100 will be difficult to break. The most important piece of U.S. data on the calendar next week is the weekly jobless claims report but a number of Federal Reserve officials including Ben Bernanke are scheduled to speak and their comments could have a larger impact on the dollar than data.

American companies boosted their payrolls by 165K last month driving the unemployment rate down from 7.6% to 7.5%. In particular, private sector job growth was solid with last month’s exceptionally weak report revised up from 88K to 138K. Average hourly earnings also increased 0.2% last month, but even though this morning’s labor market report was solid and the feel good factor should last, the data was not unambiguously positive. Manufacturing payrolls were flat, average weekly hours declined and the broader U-6 unemployment rate increased to 13.9% from 13.8%.

Yet none of this mattered to investors because the sheer of relief that payrolls exceeded 150K means that the Federal Reserve won’t need to consider increasing asset purchases. In fact, when the Fed said they could increase or decrease stimulus this week, we were extremely skeptical that they actually shifted their bias from the possibility of tapering asset purchase to increasing them especially since they left their assessment of the labor market unchanged. Now it is clear that they wanted to appear flexible when in reality they still leaned towards reducing stimulus.

EUR Enjoys Classic Post-NFP, V-Shaped Reversal

The resilience of the euro continues to impress us. Despite the European Central Bank’s rate cut on Thursday, the European Commission’s downgraded GDP forecasts and stronger than expected U.S. data, the euro traded higher against the U.S. dollar. The 1.30 level continues to provide support for the currency pair and while the euro’s reaction, Friday, was a classic V-shaped reversal that we have grown accustomed to seeing after nonfarm payrolls, the stark contrast between euro zone and U.S. economic data along with the monetary policy bias of the ECB and Fed should have kept pressure on the euro. Nonetheless, as U.S. stocks rose to fresh record highs, the EUR/USD erased its post NFP losses. At the end of the day, investors looked at the better than expected U.S. economic report as positive for global growth but we fear that major economies around world are still moving in different directions.

Part of the euro’s strength may also have to do with signs that not all European policymakers are on board with the idea of negative deposit rates. In early Europe, ECB members Nowotny and Liikanen said the market over interpreted the possibility of negative rates while Mersch said no major central bank has a negative deposit rate and the ECB has to be careful about unintended consequences. However closer to the North American open, Nowotny felt the need to clarify his stance because he was surprised by the reaction to his earlier comments and so he repeated Draghi’s view that they have an open mind about negative rates but it is “not imminent.” These back and forth comments from European policymakers signal that their primary goal yesterday was to appear to more flexible and willing to do more when in reality they are very cautious about any additional actions they plan to take. Finally, the European Commission now expects GDP growth in the region to contract by -0.4% compared to a previous estimate of -0.3%. The big change was for France whose economy is expected to contract by 0.1% instead of grow by 0.1%. The recovery in 2014 is also expected to be weaker, now estimated at 1.2% vs. 1.4% previously. For the EUR/USD, this means a test of 1.30 is likely but 1.2950 is key. In the week ahead, there are a handful of German data on the calendar but they are not expected to have as much of an impact on the EUR/USD as this past week’s releases.

GBP: Rally Capped At 1.56

While the British pound ended the day higher against the U.S. dollar, it failed at the 1.56 level for the third day in a row. Continuing the trend of upside surprises, service sector activity expanded at a faster pace in the month of April. While the increase in the PMI index from 52.4 to 52.9 is small, the mere fact that it did not decline was good news for sterling. We now know that service, manufacturing and construction sector activity improved in the month of April, easing concerns about U.K. growth and reducing the pressure on the Bank of England to ease. The BoE meets next week and they will breathe a sigh of relief that economic activity is improving. As a result, the rate decision should be a nonevent for sterling with the central bank leaving monetary policy unchanged and providing no additional clues on the outlook for the U.K. economy. Therefore a break of 1.56 should hinge less on U.K. data and more on the general risk appetite in the market. Aside from the BoE rate decision, industrial production and the trade balance are also on the calendar.

AUD: Busy Week Ahead For Australia And Canada

The Australian, New Zealand and Canadian dollars traded sharply higher against the greenback on Friday but for AUD and NZD even with the day’s rally, the pairs ended the week with losses. Australia in particular reported a series of disappointing economic releases that could make the Reserve Bank of Australia grow more dovish at next week’s monetary policy meeting. Last night, we learned that service sector activity contracted at a faster pace in April and this follows a steep decline in manufacturing activity. Their largest trading partner China also reported a slower expansion in their service sector, which does not help the outlook for Australia. In the coming week, aside from the RBA rate decision Australian retail sales, trade and employment numbers are also scheduled for release. We are looking for softer numbers all around which may make it very difficult for the AUD/USD rally to extend above 1.04. In fact, 1.0385 is the key support level for the currency. Canada does not have a monetary policy announcement next week but the IVEY PMI and employment reports are on the calendar. Unlike Australian data, Canadian data has been surprising to the upside, which suggests that we could see further gains in the CAD particularly against the AUD. Meanwhile Steven Poloz has been named the new Bank of Canada Governor starting June 3rd. Having served in the IMF, he is currently the CEO of Export Development Canada which means he may have a bias for supporting the export sector. In terms of monetary policy, this translates to the possibility of the BoC dropping its hawkish monetary policy bias.

JPY Crosses Soar On Risk Rally

The improvement in risk appetite and extension in equities helped to drive the Japanese Yen lower against all major currencies. Friday’s rally appears to have shifted the technical outlook for the Yen pairs with USD/JPY poised for another test of 100. Whether or not it breaks above this level remains to be seen. From a fundamental perspective, we don’t have a specific catalyst for the move this coming week but the residual impact of the better than expected U.S. jobs number and an extension of the equity market rally could be all that USD/JPY needs to make a run for this key level. While we believe that 100 will eventually break, traders may have to wait for a more significant catalyst before a sustainable move above this level can happen. Japanese markets are closed on Sunday evening, which is their Monday so trading should be quieter and lighter than usual in Asia. While AUD/JPY benefitted the most from the risk rally, GBP/JPY also rose to its highest level in more than 3.5 years.

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