Will Payrolls Help Or Hurt The Dollar?

All of the major currencies traded higher against the U.S. dollar Thursday with the exception of the Japanese Yen in anticipation of Friday's non-farm payrolls report. The strength of the greenback against the Yen is consistent with cautious optimism. While investors are not looking for a dramatic improvement in job growth this month, they also don't expect a significant deterioration, which is good enough for the time being. While it would be great to see blowout job growth, the chance is unlikely because most people realize that the recovery in the U.S. economy has been slow and gradual. This month's non-farm payrolls report is not expected to have a major impact on the U.S. dollar. In fact, we wouldn't be surprised if the non-farm payrolls report caused as little reaction in the FX markets as this week's FOMC meeting. Non-farm payrolls are expected to increase by 165K in the month of January, up from 155K the previous month.

Based on the leading indicators that we typically track for non-farm payrolls, a case could be made for stronger and weaker payrolls. Jobless claims have fallen significantly since last month, but most of the improvement was related to seasonal factors, which does not translate well into job growth. Both the ADP employment report and the Challenger Layoff report show a little improvement in the labor market. The plunge in consumer confidence on the other hand raises concerns about the strength of job growth. Unfortunately our favorite leading indicators for NFPs, which are the manufacturing and non-manufacturing ISM reports won't be released until next week, but the labor market reports that we have seen so far point to no major improvement or deterioration. Therefore we don't expect payrolls to hurt or help the dollar Friday. As long as the numbers aren't terrible, the existing trends in the FX market such as the EUR/USD and USD/JPY rallies should remain intact.

Here's How The Arguments For NFPs Stack Up:

• Four-Week Moving Average of Claims Rise to 352k vs 366k
• Challenger Grey & Christmas reports -24.4% drop in layoffs vs. -22.1% previous
• ADP reports 192K rise in payrolls vs. 185K in Nov.

• Continuing Claims at 3.197M vs. 3.127M
• Conference Board Consumer Confidence Drops to two-Year Low
• University of Michigan Consumer Confidence Index also Declines

The uptrend in the EUR/USD remains intact with the currency pair rising to a fresh 14 month high during the North American trading session. German economic data was mixed, but when a trend is as strong as the one in the EUR/USD, it doesn't take much in the way of good news to push the currency pair higher. Investors completely ignored the drop in German retail sales and focused exclusively on the decline in unemployment. Their optimism is certainly justified as our colleague Boris Schlossberg pointed out that "The positive news on the labor front is much more important than the dip in consumption. The increase in jobs will lead to higher incomes which in turn should help boost consumption in Euro-zone's largest economy as the year proceeds. Unemployment declined by a whopping -16K versus expectations of a rise of 10K. Improving business confidence especially amongst the small to medium sized companies has been a key driver of demand as Germany continues to rebound from the Q4 slump. German Retail Sales printed far worse than expected plunging -1.7% versus forecasts of -0.1% decline as consumers clearly shut their purse strings tight during the slowdown in Q4. Part of the drop was attributed to calendar effects, but even on a calendar adjusted basis December turnover was considerably weaker than anticipated." If there aren't any major surprises in NFPs, the EUR/USD could break 1.36, especially if Friday's euro zone economic reports surprise to the upside. Final euro zone PMI manufacturing numbers are due for release (no major revisions are expected) along with euro-zone CPI estimate and unemployment. Don't forget that the ECB also announces its LTRO repayments Friday around 11am GMT.

CAD: Lifted By Stronger GDP
The Australian, New Zealand and Canadian dollars ended the day higher against the greenback. The CAD benefitted from stronger than expected GDP numbers. Canadian GDP growth increased from 0.1% to 0.3% in the month of November, which was the fastest pace of growth in 7 months. Considering that retail sales and trade deteriorated significantly according to the latest reports, it is hard to believe that this strength can be sustained but nonetheless growth beat expectations, which helped drive USD/CAD back below 1.01. Thursday night should be a busy one for the Australian dollar with producer prices due for release along with PMI manufacturing numbers for Australia and China. The AUD/USD is trading like the market expects a rate cut from the RBA. Lower inflationary pressures (which is likely) and weaker manufacturing activity would support that belief and could drive the AUD/USD below 1.04. Weak PPI alone however probably won't do the trick. As for China, according to the HSBC's Flash PMI report, manufacturing activity accelerated in January. Now its time for the government's official release and a similar improvement could lend support for the AUD/USD. Of the three commodity currencies, the NZD/USD performed the best as it continued to benefit from the RBNZ's optimistic comments.

GBP: Rebounds On Stronger Data
The British pound rallied against both the euro and U.S. dollar on the back of better than expected economic data. Consumer confidence in the U.K. improved significantly in the month of January according to a report from GfK. The 3 point increase in the index can be attributed to a better outlook for the economic situation and prospect for retailers. Unfortunately there was strength beneath the headlines with consumers growing more pessimistic about their personal finances. Concern about finances could spell more trouble for the U.K. economy going forward. House prices on the other hand increased by 0.5% according to Nationwide and this improvement is consistent with the stability seen in the sector during the month of January. The U.K.'s manufacturing PMI report is due for release Friday and based on the sharp decline in a similar survey conducted by the Confederation of British Industry, manufacturing activity slowed significantly. If the PMI falls short of expectations and shows the sector contracting, we could see a reversal in the GBP/USD.

JPY: Rally In Nikkei Supports Uptrend In USD/JPY
The Japanese Yen continued to weaken against all of the major currencies and as a result, has dropped to fresh multi-year lows against the U.S. dollar, euro, British pound and New Zealand dollar. The uptrend in the Yen pairs remains intact and for the time being, there's no fundamental reason to fade the trend. There are signs of improvement in Japan's economy according to the latest manufacturing PMI and industrial production reports. Unfortunately the improvements are still relatively modest with manufacturing activity contracting and industrial production rebounding less than expected. So far, the weakness of the Japanese Yen has only provided limited support for Japan's economy. Of course, it is far too early to tell but external factors such as Japan's dispute with China continues to weigh on growth. Labor market numbers are due for release this evening along with overall household spending -- no major changes are expected. If there are no improvements in Japan's economy soon, the Bank of Japan could be forced to increase asset purchases this year, which could be just what USD/JPY needs to hit 95.

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