By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
With the Bank of England and Reserve Bank of Australia monetary policy announcements behind us, the focus turns to the U.S. nonfarm payrolls report. In many ways, the moves in other major currencies have been restrained by the uncertainty surrounding this month’s jobs report. There’s only 2 more before the next Federal Reserve meeting and it is becoming increasingly difficult for investors to believe that it will raise interest rates one more time this year. Between concern about inflation posed by Fed President Bullard and Thursday morning’s surprisingly weak non-manufacturing ISM report, the Fed’s hawkish bias is running on faith alone — UNLESS Friday’s jobs report is unambiguously positive, restoring the market’s confidence in the economy, the U.S. dollar and the central bank.
Unfortunately, based on a number of labor-market indicators that we typically follow, the argument for a strong report is weak. Aside from the drop in the employment component of non-manufacturing ISM, private payrolls also fell according to ADP, continuing claims increased and sentiment is at a 9-month low according to the University of Michigan consumer sentiment index. The UMich survey is offset by the Conference Board’s consumer confidence report, which increased, but the improvement in the 4-week average jobless claims was small, the increase in the employment component of manufacturing ISM is not incorporated into the headline report and fewer layoffs don'y always translate into stronger job growth. When it comes to the payrolls report, the absolute amount of job growth is almost less important than the unemployment rate and average hourly earnings. Both wage growth and the unemployment rate are expected to improve and if any one of them miss expectations and holds steady or worsen, USD/JPY will drop to 109.50. However if wage growth and the unemployment rate improve, USD/JPY will find its way back to 111.50.
Arguments For Stronger Payrolls
- Conference Board Confidence Index Rises to 121.1 from 118.9
- 4 -Week Average Jobless Claims Drops to 241K from 243K
- Employment Component of Manufacturing ISM Rises to 57.2 from 53.8
- Challenger Reports 37.6% Drop in Layoffs
Arguments For Weaker Payrolls
- ADP Drops to 178K from 191K
- Employment Component of Non-Manufacturing ISM Sinks to 53.6 from 55.8
- University of Michigan Consumer Sentiment Index Falls to 9 Month Low
- Continuing Claims Rise to 1.968M from 1.965M
Sterling's outlook, on the other hand, is unambiguously negative following the Bank of England’s monetary policy announcement. The central bank voted 6-2 to leave interest rates unchanged, cut its forecasts for GDP and wage growth and expressed concerns about a “smooth transition to a new economic relationship with the EU.” Governor Carney said the bank’s forecast revisions factor in “uncertainty about the eventual shape of the U.K.’s relationship with the EU, which weighs on the decisions of businesses and households and pulls down both demand and supply.” Not all of his comments were negative as Carney sees growth picking up later in investment and trade with the economy supply capacity rising at a modest rate. As a result, some tightening will be needed in the next 3 years with 2 rate hikes likely to be insufficient. While Carney did talk rate hikes, the 3-year time horizon is just too long for a market looking at another hike from the Fed this year and some type of movement from the ECB. The central-bank’s forecasts are based on the first hike happening in the third quarter of 2018, which is longer than sterling bulls could have hoped. Given how much GBP/USD has risen in the last 4 months (from 1.24 to 1.3250), the tone of Thursday’s central-bank meeting should be enough to confirm 1.3270 as the top in sterling. Euro, on the other hand, continued to march higher although a new high was not reached Thursday. Investors completely shrugged off downward revisions to Eurozone PMIs to focus exclusively on stronger Eurozone retail sales and softer U.S. data.
The U.S. is not the only country scheduled to release labor data on Friday. We’ll also get to see if labor-market conditions eased in Canada after 2 strong months. If job growth slowed, it could extend profit taking in USD/CAD, but the amount of full-time employment will be key. If the net change increases by only 10-20K and full-time work is strong, then USD/CAD could still resume its slide. Yet if full-time jobs are lost, any amount of part-time growth may not be enough to make up the difference. Aside from the employment report, IVEY PMI is also on the docket and the pace of manufacturing growth will be just as important as investors scrutinize every piece of CAD data for weakness. Meanwhile, the Australian dollar extended its slide despite mixed data — the country’s trade balance weakened significantly but service-sector activity increased. Retail sales and the central bank’s monetary policy statement were due Thursday evening and both were expected to be negative for the currency. AUD has peaked and the next stop for the pair should be 78 cents.