Behind Friday's Post-NFP FX Reversal

Behind the Post-NFP FX Reversal

When the U.S. non-farm payrolls report was first released, currencies and equities traded sharply higher on the relief that non-farm payrolls did not miss expectations for the third month in a row. However within the first hour of the stock market open, trends began to reverse and by the end of the North American session, most of the earlier gains were lost. The sell-off was triggered by the one major uncertainty that has been hanging over the markets for the past few weeks and that is Ukraine. Around the NY open, Russia's Gazprom threatened to halt gas supply to the Ukraine for their late payments. According to the Chairman, Ukraine owes close to $1.9 billion for their February supplies. Considering that the Russian government owns a controlling interest in Gazprom, the world's largest single gas producer, this threat is clearly representative of political posturing. Threatening Ukraine gas supplies is an indirect way of threatening the European gas market because a large portion of the oil that Europe receives flows through Ukraine. As the day progressed, there were also reports that armed forces thought to be Russian military have attempted to take control of a Ukrainian military post in Crimea. These developments serve as a harsh reminder that while the Ukraine crisis is no longer the top banner on CNN.com, it hasn't faded to the sidelines. Crimea is scheduled to hold a referendum on seceding from Ukraine and joining Russia in 10-days time but President Obama has called this vote a violation of international law. These conflicting views imply that the crisis could worsen before it improves, posing a major risk for the financial markets. With no major Eurozone or U.S. economic reports scheduled for release next week outside of Thursday's U.S. retail sales report, geopolitical uncertainty should be the leading driver of currency and equity flows at the front of the week. Keep an eye on EUR/USD because it will be one of the currency pairs most sensitive to headlines out of Ukraine. The charts show an ugly intraday reversal that could turn into losses on Monday. Euro-area finance ministers are meeting in Brussels next week and aside from this meeting, the only marginally market moving piece of data on the Eurozone calendar is the German trade and current account balance on Thursday. While the stronger NFP report should renew demand for dollars, the ECB's recent optimism will also limit the currency pair's slide.

USD: Finally a Good Jobs Number

Before this morning's labor market numbers were released, many Fed officials including Dudley and Yellen pledged to continue to taper, saying it would take a significant change in the economic outlook to veer the central bank off its course. With non-farm payrolls rising 175k in the month of February, up from 129k, there's no question that the Fed will reduce asset purchases by another $10 billion this month but they also have more flexibility now to change forward guidance. Although the unemployment rate increased, investors bought dollars aggressively on the back of the release because 60k people re-entered the workforce. Average hourly earnings also rose 0.4%, the strongest pace of growth in 8 months. The broader U-6 unemployment rate dropped to 12.6% from 12.7%, its lowest level since November 2008. If not for inclement weather, which made it difficult for 600k people to get to work, the non-farm payrolls report would have been even stronger. We are now looking at a potentially significant increase in March payrolls as long as jobless claims remain low. As shown in the price action of USD/JPY, Friday's report is a good number for the U.S. dollar. In the Beige Book, the Fed said the economy grew over the past month even as harsh weather slowed hiring. With Friday's release, concerns about the slowdown will ease paving way for a stronger dollar rally ahead of the March 19th FOMC announcement. Friday's number is a big relief for the central bank whose optimism about the economic outlook came into question with every piece of disappointing data. Janet Yellen's decision to continue reducing purchases will now receive more support than skepticism. The central bank is widely expected to drop its 6.5% unemployment rate threshold this month and adopt qualitative guidance. Barring a negative retail sales report next week and an all out war with Russia, we expect USD/JPY to quietly trickle higher towards 105.

USD/CAD Soars on Surprise Contraction in Canadian Jobs

Of all the major currency pairs, the biggest mover Friday was the Canadian dollar. The loonie sold off sharply versus the U.S. dollar and euro, losing nearly 1%, which is considered a big one day move for these pairs. The trigger was a surprisingly weak employment report. Economists were looking for job growth to slow from 29.4k to 15k in February but instead, 7k jobs were lost last month, erasing any optimism created by the stronger building permits and IVEY PMI report. Although all of the jobs lost were part time and full time employment increased, the fact that no jobs were created in February will make the Bank of Canada cautious about the outlook for the economy. When the BoC met earlier this week, their statement was slightly more dovish than the previous month. They acknowledged that growth towards the end of last year was slightly stronger than anticipated but warned that Q1 growth is likely to soften. The Canadian central bank was particularly worried about the underperformance of exports and felt that the downside risks to inflation remain important. Next week will be all about the New Zealand dollar. The RBNZ is expected to change interest rates for the first time since 2011. If they raise rates, it would be the first tightening by a major central bank since the global financial crisis. For the Australian dollar, the most important event risk will be the February employment report.

GBP: Inflation Expectations Fall to Feb 2010 Low

The British pound traded lost value against the U.S. dollar and euro on the back of Ukraine uncertainty and lower inflation expectations. According to the central bank's latest survey inflation expectations for the year ahead dropped to its lowest level since February 2010. This decline gives the Bank of England greater flexibility to keep monetary policy easy because one of the greatest risks of ultra accommodative policies is inflation. While the BoE hinted that the first rate hike will come in Q2 of 2015, they are in no rush to raise interest rates. Next week's industrial production and trade balance reports are not expected to be major movers for the British pound. Instead, sterling will most likely take its cue from risk appetite and the ongoing developments in Ukraine. The positive comments from ECB President Draghi this week should lead to more profit taking on short EUR/GBP positions. The latest CFTC IMM report shows that long GBP/USD positions continued to climb this week but the sample was taken before the ECB rate decision.

BoJ Will the BoJ Increase Stimulus?

The Japanese Yen traded lower against all of the major currencies Friday with the exception of the Canadian dollar, which underperformed due to weaker employment numbers. While this has been a quiet week for Japanese data, 4 central bank rate decisions and the non-farm payrolls report increased the volatility in the Yen crosses. With only a month to go before the consumption tax is increased, growth in Japan is not as strong as everyone had hoped for as recent economic reports suggest that the momentum has slowed. A number of important economic reports are scheduled for release in the week ahead that will provide us with greater insight into how well Japan's economy is doing. This includes the trade balance, Eco watchers survey, consumer confidence and industrial production. The Bank of Japan also has a monetary policy meeting. Many economists believe that the central bank will be forced to ease in the second quarter but we would not be shocked if they increased stimulus before the tax hike to provide greater cushion for the economy.

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