Beware Of The ECB‏

EUR: Beware of the ECB
USD: What to Expect for NFPs
GBP: Carney to Leave Policy Steady at First BoE Meeting
AUD: Hits New Lows, Eyeing 90 Cents
USD/CAD: Retreats from 1 Year High
NZD: Service Sector Activity in China Slows
JPY: Labor Cash Earnings Unchanged

EUR - Beware of the ECB

On the eve of the European Central Bank's monetary policy meeting, the euro is trading well. Having dropped to a low of 1.2923 on an intraday basis, the currency staged a strong recovery against the dollar, ending the North American session around 1.30. The magnetism of this key level has been nothing short of impressive especially considering the political troubles in the Eurozone and mixed economic data. The bounce in the euro can be attributed to the pullback in Portuguese 10 year bond yields, which hit a high of 7.977% before settling down at 7.33%, up 68bp for the day. While the European Central Bank is widely expected to leave interest rates unchanged, they won't be happy to see the recent volatility in the European equity, currency and bond markets.

Since the last ECB meeting, we have seen more improvements than deterioration in the Eurozone economy. In Germany specifically, consumer spending has been healthy, unemployment rolls have declined, leading to an improvement in business and investor confidence. However the strength was not without areas of weakness. Businesses and investors grew more optimistic about future economic activity but more grim about current activity. Considering that the current performance of the economy is what really matters, the ECB may look beyond everyone's hope for improvement. Also stronger service sector activity in the region's largest economy was offset by a deeper contraction in manufacturing. So as you can see the recovery in the Eurozone is uneven and when combined with a 5% sell-off in the DAX, since the last meeting the ECB has very little to be optimistic about.

Furthermore, a political crisis has hit Portugal, putting the region at risk of greater uncertainty and turmoil. The crisis was kicked off by the resignation of the leader of the junior party. If a grand coalition cannot be formed, the government may be forced to hold early elections, which would be negative for the euro because it would mean the collapse of the current government. This political uncertainty combined with mixed Eurozone data and the recent volatility in the financial markets leads us to believe that ECB President Draghi will retain an open mind on non-standard monetary policy measures including negative deposit rates and remind investors that they are in a very different position from the Federal Reserve and as such will keep rates low for as long as necessary. In a nutshell, we don't think Draghi will have anything kind to say for the euro and if his level of dovishness increases, it could drive the currency pair to 1.29. In the off chance that he surprises with optimism, 1.30 could become a bottom for EUR/USD.

USD - What to Expect for NFPs

The U.S. dollar traded lower against all of the major currencies yesterday with the exception of the Australian dollar. With the release of mostly better than expected U.S. economic reports, the sell-off in the greenback suggests that some traders are squaring dollar long positions ahead of the July 4th holiday. U.S. markets are closed today but the ECB meeting could still trigger volatility in the early part of the session. Trading will most likely grind to a halt however after the European close. Since we won't be publishing an end of day piece today, we want to take this opportunity to discuss the payrolls report. Based on the leading indicators for NFPs, we expect the pace of growth to be maintained. The increase in the employment component of non-manufacturing ISM, ADP report and the low level of jobless claims supports a stronger release but consumer confidence has been mixed and layoffs increased according to Challenger Grey & Christmas. What the market is really focusing on is the unemployment rate. Economists expect the jobless rate to fall from 7.6% to 7.5%. Given the Federal Reserve's decision to lower their forecasts for the unemployment rate, the market is looking for a similar improvement. If the number comes out as expected, the dollar could extend its gains but if the unemployment rate holds steady, long dollar positions could be unwound as investors question the Fed's prudence on tapering asset purchases this year. Meanwhile yesterday's U.S. economic reports were mostly better than expected but the general anti-risk sentiment in the financial markets caused USD/JPY to reverse its gains and more specifically drove the Japanese yen higher against all of the major currencies. The dollar received only a minor lift from better than expected labor market numbers. Jobless claims dropped to 343K in the week of June 29th from 348K. According to private payrolls provider ADP, U.S. companies added 188K workers last month, up from 134K. Service sector activity slowed in the month of June with the ISM non-manufacturing index dropping to 52.2 from 53.7. Despite this decline, the outlook for the labor market and Friday's NFP report is still bright because job growth increased in the service sector last month. The employment component of the ISM non-manufacturing index rose to its highest level since February, which still points to a strong NFP release.

GBP - Carney to Leave Policy Steady at First BoE Meeting

The British pound strengthened against the major currencies yesterday thanks to the service sector, which grew at its strongest pace in more than two years in June. Economists had been looking for service sector activity to slow but instead of doing so, it accelerated quickly. The index by Markit Economics and the Chartered Institute of Purchasing and Supply rose to 56.9 from 54.9. Markit said, "The buoyant picture for June means the economy is on course to expand by at least 0.5% in the second quarter, with more growth to come." A report by the British Retail Consortium revealed that shop price inflation declined in June at its fastest pace in more than six years. The BRC said, "The deflation is driven entirely by non-food, a reflection that the summer sales are well underway as retailers battle it out to shift stock and compete for customer spending. The volatile weather also had a part to play in pushing down non-food prices." Earlier data this week showed the construction and manufacturing sector expanding and this trifecta of growth will leave the Bank of England firmly on hold today. It will be the first monetary policy meeting for BoE Governor Mark Carney who took office on July 1st.

AUD Hits New Lows, Eyeing 90 Cents

The Australian dollar fell to fresh lows against the US dollar while the Canadian and New Zealand dollars rebounded yesterday. Considering that Australian economic data was mixed, the sell-off in the AUD was driven entirely by the dovish comments from Reserve Bank of Australia Governor Glenn Stevens who reiterated his view that the country was now transitioning from a commodity boom and the Aussie would need to be lower in order for Australian businesses to compete. According to our colleague Boris Schlossberg, interest rate futures spiked on his words with markets now pricing in a 60% chance of a rate cut at the next RBA meeting in August. When the RBA met a day prior Stevens said, "We have to negotiate the downward phase of the investment boom over the next few years, which appears likely to pose significant changes." He said that "confidence seems pretty subdued right now." "Much depends on confidence - that intangible thing that is hard to measure and very hard to increase." Stevens was optimistic about China, who is Australia's largest trading partner even though we have seen nothing but downward surprises. Overnight yestereday, China's non-manufacturing PMI index dropped to 53.9 from 54.3. Meanwhile Australia's trade balance rose to $670M AUD in May exceeding forecasts for a $53M AUD surplus. The Australian Bureau of Statistics revealed that retail sales were rose to 0.1% in May, when economists had anticipated a 0.3% rise. Service sector activity accelerated to 41.5 in June, up from 40.6 in May.

JPY - Labor Cash Earnings Unchanged

The Japanese yen strengthened against all of the major currencies yesterday with the exception of the British pound. A report by the Labor Ministry revealed that Japan's labor cash earnings stayed unchanged for a second consecutive month. The Bank of Japan said the economy is "picking up" in its current assessment report. In its next policy meeting next week, the bank may divulge more on what they mean. The bank raised the assessment for seven consecutive months which may be beneficial to Prime Minister Shinzo. Gaining popularity by maintaining economic growth will help Abe in an upper house election coming this month. Abe wants to gather support for the package of monetary and fiscal stimulus and business deregulation through Abenomics.