Euro Survives -- Next Up, NFP

Euro Survives Negative Rates, What to Expect for NFP

For the first time ever, banks in Europe will be required to pay the ECB for the right to park their reserves with the central bank. While smaller countries have introduced negative rates in the past, this is the very first time that it is implemented on a large-scale basis by one of the world's most important central banks. This negative deposit rate is the boldest step that the ECB has taken so far to stimulate growth and inflation in the region's economy. But a negative rate was not the only announcement made by the central bank Thursday. Mario Draghi introduced a package of measures that included a series of rate cuts, 2 targeted longer-term refinancing operations, the end of sterilization of their SMP program, an extension of their fixed rate allotment and preparations for outright purchases of ABS securities. Most importantly, when asked about the potential for more stimulus including Quantitative Easing, Draghi said "we're not finished."

This package of aggressive measures and the central bank's willingness to do more should have been negative for the euro and it was initially but by the end of the North American trading session EUR/USD recovered all of its losses to end the day in positive territory. This counterintuitive price action has left many traders confused. However if we take a look at how the EUR/USD behaved after the rate cut in November, the U-turn in the currency pair is not without precedent. Thursday, just as in November, investors were impressed by the central bank's radical measures and based on the rally in equities they believe the active approach to monetary policy will be enough to stimulate growth. Also, Draghi said interest rates are pretty much at their lower bounds, which means they are not considering additional rate cuts. At the same time, the steps taken by the ECB Thursday are more benign than the Quantitative Easing measures implemented by the Federal Reserve, Bank of Japan and the Bank of England. So while the ECB maintains a dovish bias and has made it clear that they are not done easing, for the time being investors perceive Thursday's announcements to be positive for the Eurozone economy and for the euro.

My Top 15 Takeaways from ECB Announcement & Draghi Press Conference

1. ECB Delivers Massive Stimulus Package, Talks of Doing More -- Markets Should be Impressed
2. ECB Did NOT Announce Quantitative Easing Thursday but Took a Step in that Direction
3. Eurozone Gets Negative Deposit Rates of -0.1% - Expected but still unprecedented for ECB
4. Main Refinancing Rate cut to 0.15%, Marginal Lending Rate cut to 0.4% - Expected
5. Draghi says Interest Rates Pretty Much at Lower Bound - Translation No More Rate Cuts
6. ECB extends eligibility of existing assets as collateral - Allows more loans to be used for LTROs
7. Announces 2 Targeted longer-term refinancing operations (TLTROs) in September and December (Initial Size of EUR400B)
8. Preparation for outright purchases of asset backed securities (ABS) intensified - Step Towards QE
9. Ends Sterilization of Securities Markets Program - Expected
10. ECB Extends Fixed Rate Full Allotment until end of 2016
11. More stimulus is possible, Draghi says point blank "We're not finished"
12. Main motivation for Thursday's moves were low inflation - ECB cuts 2014, 2015 and 2016 Inflation Forecasts
13. ECB also cuts 2014 GDP forecast, raises 2015 GDP forecast
14. While Draghi sees continued recovery and moderate growth in Q2, outcome has been weaker than expected
15. Draghi recognizes improvements in labor market but says unemployment remains high and unutilized capacity still sizable

USD: What to Expect from June NFP

With the European Central Bank monetary policy announcement behind us, traders can now turn their focus to the U.S. non-farm payrolls report. We do not expect the foreign exchange market's reaction to NFPs to be as significant as their reaction to the ECB but the monthly jobs number is always worth watching particularly with USD/JPY trading near 103. While job growth is the backbone of the U.S. economy, unless non-farm payrolls exceeds 350k or drops below 125k, the Federal Reserve won't feel inclined to reevaluate their plans for monetary policy. This is singlehandedly the most important point to remember which is that unless payrolls is strong or weak enough to prompt the Fed to slow or accelerate their plans for tapering, the impact on the dollar will be limited. The consensus forecast for NFPs calls for less job growth in the month of May. Only 215k jobs are expected to have been created, down from 288k jobs in April but judging from the other labor market indicators released over the past few weeks, there's just as much reason to believe that job growth could surprise to the upside. The arguments in favor of weaker payrolls rest primarily with the strong reading in April. Many economists believe that there was a pullback last month caused in part by seasonal, holiday adjustments. Challenger Grey & Christmas also reported a significant increase in layoff announcements while ADP reported a drop in corporate payrolls. However jobless claims have been trending downwards with the 4-week moving average falling to its lowest level since March 2007. Continuing claims also fell to a 6-year low and most importantly ISM reported an increase in employment last month. For these reasons, we think that non-farm payrolls could surprise to the upside, driving USD/JPY towards 103. However unless the unemployment rate drops to 6.1% or better, we don't expect this level to be broken in a significant way.

Arguments for Stronger Payrolls

• SM Non-Manufacturing Employment Component Rises to 52.4 from 51.3
• Conference Board Consumer Confidence Index Rises to 83 from 81.7
• Jobless Claims 4-Week Moving Average Drops to Lowest Level Since March 2007
• Continuing Claims Fall to 6-Year Low

Arguments for Weaker Payrolls

• Challenger Grey & Christmas reports 45.5% increase in layoff announcements, biggest rise since August 2013
• ADP reports 176k rise in payrolls vs. 215k in April
• ISM Manufacturing Employment Component Drops to 52.8 from 54.7
• University of Michigan Consumer Confidence Index Drops to 81.9 from 84.1

GBP: BoE Leaves Monetary Policy Unchanged

The British pound ended the day slightly higher against the U.S. dollar and euro. The Bank of England's decision to leave interest rates and the size of their Quantitative Easing program unchanged was widely anticipated by the market. So instead, the strength of sterling stemmed from the improvement in risk appetite and the European Central Bank's monetary policy announcement. On an intraday basis, EUR/GBP dropped to a fresh 1-year low but with the turnaround in the euro, the currency pair managed to climb back above 0.81 cents. Despite calls for the Bank of England to raise rates, policymakers have refrained from expressing any desire to do so. Thursday's decision by the ECB could harden their commitment to keep monetary policy easy and further reduce the chance of early tightening because if euro weakens against sterling, a stronger U.K. currency would drive inflation lower. Nonetheless the latest economic reports show the U.K. economy performing well. House prices jumped 3.9% last month according to Halifax - the housing market continues to be the only area of the economy with inflation. Although the trade balance is scheduled for release Friday, it will most likely take a back seat to the non-farm payrolls report and continued euro flows.

CAD: Steep Decline in IVEY PMI Validates BoC Outlook

The rally in global equities and improvement in risk appetite drove the commodity currencies higher against the U.S. dollar. The desire to own risk was so strong that it overshadowed continued weakness in Canadian data. According to the IVEY PMI report, manufacturing activity contracted at its fastest in 6 months while building permits rebounded only 1.1% after falling 3.2% the previous month. Economists had been looking for a stronger 4.2% recovery. Thursday's reports validate the Bank of Canada's pessimistic economic outlook. Earlier this week the central bank said the weaker global outlook increases the downside risk for Canada, especially now that the U.S. economy is losing momentum. These uncertainties led the central bank to leave their assessment of inflation unchanged -- they continue to see downside risks despite the positive impact of a weaker currency and higher energy costs. Canadian employment numbers are scheduled for release Friday and a significant rebound in job growth is expected after the steep slide in April. Unfortunately based on contraction in the employment component of IVEY PMI, there's a good chance that job growth could fall short of expectations. Meanwhile the best-performing currency Thursday was the New Zealand dollar. With no economic data released overnight, Thursday's recovery was driven entirely by the improvement in risk appetite. The Australian dollar also extended its gains despite an unexpected trade deficit in April. The rally was also supported by a rise in HSBC's China Composite PMI index. Good news from Australia's largest trading partner is generally positive for the currency. For the first time in 4 months, HSBC reported an expansion in economic activity, a sign of a bottom in China's economy.

JPY: Japanese Investors Swap Bonds for Stocks

Once again, there was very little consistency in the performance of the Japanese Yen Thursday. New record highs in U.S. stocks should have been overwhelmingly positive for USD/JPY but the currency pair failed to rally because Treasury yields moved lower. Investors remain cautious ahead of Friday's non-farm payrolls report. There was no major data released from Japan overnight. According to the Ministry of Finance's weekly portfolio report, Japanese investors were net sellers of foreign bonds and net buyers of foreign stocks. Their purchase of stocks was the strongest since March 2009 and their sale of bonds was the largest since March 28th. This implies that Japanese investors are dipping their toes back into the market and becoming increasingly attracted to the returns in global equities. Japanese stocks continue to hold up well with the Government's Pension Investment Fund increasing its allocation to equities in the second quarter. Leading indicators are scheduled for release Friday -- slightly softer results are expected.

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