Imminent Taper Fades As Traders Sell Dollars

USD: Tapering Off The Table

Investors sold the U.S. dollar against all of the major currencies Tuesday after weak payrolls growth took tapering completely off the table for 2013. Even though the unemployment rate dropped to a nearly five-year low, only 148k jobs were created last month. At the last FOMC meeting, Bernanke downplayed the significance of improvements in the unemployment rate by saying that it “can be an inaccurate measure of labor market conditions” and what they really want to see instead is an overall improvement in the labor market. He even said there is no magical number for the jobless rate even though 6.5% is their target. The reason is obvious. The Fed is worried about sluggish payroll growth and after Tuesday’s release they should be even more concerned. As result, there’s next to zero chance that the central bank will reduce asset purchases this year especially with uber dove Janet Yellen replacing Bernanke in 2014 – she may exert her influence stronger as the year ends and the current Fed Chairman could choose to defer to her better judgment since she will be inheriting the economy in a few months time.

Like the Fed, the market has ignored the improvement in the unemployment rate to 7.1% from 7.3%, choosing instead to hone in on the sluggish pace of job growth. Not only did the U.S. dollar weaken but 10-year Treasury yields also fell from 2.6% to 2.51% after NFPs. The S&P 500 on the other hand climbed to fresh record highs as Tuesday’s report ups the odds of Fed tapering in 2014 versus 2013. Without stronger payrolls, the drop in the unemployment rate is unconvincing especially since labor force participation fell to a 35 year low. Average hourly earnings growth also slowed to 0.1% from 0.4% the previous month. The only good news was that the 24k upward revision to the August report took away some of the sting.

The problem for the Fed is that job growth slowed in September and the next two reports will be distorted by the U.S. government shutdown. The October numbers are expected to be weak but the November numbers should be strong as Americans return to work and U.S. corporations unfreeze their expansion and investment plans. The next jobs number will be released in 2.5 weeks at which time we will get to see how much damage political paralysis had on the economy. The October report will be particularly vulnerable to revisions and for all of these reasons, the Fed will find it very difficult to legitimately pull the trigger on tapering before the end of the year. As Fed President Evans said yesterday, it could take a few months to sort out the U.S. labor market picture. However they will need to taper soon if the unemployment rate continues to fall at its current pace as the 6.5% target could be reached in the first half of the year if not sooner. For the time being, we expect rates to remain suppressed into December, putting continued pressure on the greenback but while we expect the dollar to remain weak, we don’t anticipate a full fledged collapse in USD/JPY because tapering is still set to begin in early 2014. The timing hinges upon whether Yellen feels that they can wait to see how debt negotiations play out in January / February before reducing asset purchases.

EUR Closes In On Two-Year Highs

The euro rose to its strongest level against the U.S. dollar since November 2011. Weaker than expected U.S. jobs data sent the currency soaring against all of its peers. No euro zone economic data was released but fundamentals are driving currency flows. The ECB is not in any position to tighten monetary policy but there’s a lot of euro-zone data scheduled for release this week and depending on how they fare, expectations for euro-zone growth could change and the euro could head even higher. The central bank is cautious but there is a lot of hope that the region will benefit from the opportunity for renewed growth in the U.S. and China. We have already seen a significant pickup in investor confidence as measured by the ZEW survey and this week the latest PMI reports and the German IFO survey are scheduled for release. Economists are looking for mild but broad based improvements but if the data is strong, the EUR/USD could not only break 1.38 but also 1.39. Unfortunately we’ll have to wait until Wednesday for a euro-zone catalyst because the only piece of data from region worth watching Wednesday is euro-zone confidence. Meanwhile the Swiss Franc also rose to its strongest level against the U.S. dollar in nearly two years thanks to the combination of stronger Swiss data and dollar weakness. The country’s trade balance surged to 2.49B from 1.86B in the month of September. Exports rose 2% while imports rose 3.1%. Both figures were strong and represent a sign of recovery for Switzerland’s economy.

GBP: Bank Of England Minutes Due For Release

The British pound traded higher against the U.S. dollar on the back of stronger public sector finances. Net borrowing in the month of September was only 11.1 billion, down from 12.5 billion the previous month. Stronger growth and higher tax receipts are helping to repair the U.K.’s fiscal finances and if this trend continues, the Chancellor will have no problems meeting his deficit reduction targets. Wednesday, the Bank of England releases the minutes from its last central bank meeting. Policymakers met under the backdrop of fresh weakness in U.K. PMIs and U.S. fiscal debt troubles, which may have kept all 9 members of the Monetary Policy Committee in favor of leaving Quantitative Easing, unchanged in the month of October. The last time the BoE met, MPC member miles voted against an increase in QE, making the central bank as a whole less dovish. We don’t think there are enough concerns about inflation or stronger growth within the central bank to support tighter monetary policy at this time. However if there is it would be just what the GBP needs to break its 2013 highs.

CAD: What To Expect From The BoC

After a one-day pause, commodity currencies resumed their rise against the U.S. dollar. The strongest gains were seen in the NZD and AUD as weaker economic data held back the CAD. Canadian retail sales growth grew by only 0.2% in the month of August after rising 0.5% the previous month. This was the second month in a row that spending increased and even though growth slowed, the absolute amount of spending matched a record set earlier this year. For the Bank of Canada who meets Wednesday, the pullback in spending will not be a major concern. However, the impact of the U.S. government shutdown on growth could keep the central bank cautious. Manufacturing activity only saw a slight improvement in the month of September while job growth slowed. When we last heard from the central bank, they sounded more cautious about the economic outlook but their guidance on interest rates remained unchanged. The BoC still believes that “over time, as the normalization of these conditions unfold, a gradual normalization of policy interest rates can also be expected, consistent with achieving the 2% inflation target.” In other words, their next move is to raise and not lower interest rates. Yet for the time being, they are comfortable with the current level of monetary policy, a view that we expect to be repeated this month. We do not expect the BoC rate decision to have a significant impact on the Canadian dollar. Australia will also release its third quarter CPI numbers. Inflationary pressures are expected to increase on a quarter to quarter basis but slow significantly year over year.

New Highs For The Yen Crosses

The strong performance of U.S. equities and the overall improvement in risk appetite helped to drive all of the Japanese Yen crosses higher. EUR/JPY, CHF/JPY and NZD/JPY performed particularly well with EUR/JPY climbing to a fresh three-year high and CHF/JPY to a five-year high. Since there was no Japanese economic reports released overnight, the move was driven entirely by demand for high beta currencies especially because USD/JPY ended the day unchanged. EUR/JPY can be particularly sensitive to the movements in equities as indicated by recent price action. If U.S. stocks continue to rise, we may see further gains in these Yen pairs. Disappointing U.S. jobs data should have driven USD/JPY sharply lower Tuesday but demand for the Yen crosses helped lend support to the pair. There were no economic reports scheduled for release from Japan Tuesday evening, which means the Yen will continue to trade on the market’s appetite for risk.

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