By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
Friday’s U.S. Nonfarm Payrolls report is the most important event risk this week and investors are trading USD/JPY like a strong number is guaranteed because despite Thursday’s softer releases, USD/JPY is holding above 113. Yet Janet Yellen’s positive outlook and the softness of last month’s report are the only reasons why Friday’s jobs number could be strong. Service-sector activity accelerated in June, but the employment component dropped to 55.8 from 57.8, reflecting slower job growth. ADP also reported its smallest payroll increase since October. The 4-week average jobless claims ticked up from last month as continuing claims rose to its highest level since mid April. Consumer confidence is mixed, leaving Challenger’s 19.3% reduction in layoffs as the only piece of data supporting stronger payroll growth since manufacturing jobs are a separate line item in the Nonfarm Payrolls report. Considering that the U.S. dollar is held up primarily by the Fed’s hawkishness, investors may not tolerate another month of weak job growth and could send the greenback sharply lower if NFP miss. However if Payrolls rise by 175K or more AND average hourly earnings increase 0.3% or greater, Yellen will be vindicated and USD/JPY will hit 114 and beyond.
Payrolls Preview
Arguments For Stronger Payrolls
- Challenger Job Cuts -19.3%
- Employment Component of Manufacturing ISM Rises
- Consumer Confidence Rises to 118.9 from 117.6
Arguments For Weaker Payrolls
- Employment Component of Non-Manufacturing ISM Drops to 55.8 from 57.8
- ADP Employment Falls to Lowest Level Since October
- 4-Week Jobless Claims Average Rises to 243K from 239K
- Continuing Claims Rises to 1.956M from 1.929M
- University of Michigan Index Drops to 95.1 from 97.1
Thursday's best-performing currency was the euro, which outperformed all of the major currencies on the back of European Central Bank hawkishness. According to the ECB’s account of it last monetary policy meeting, the “governing council considered whether to adjust their QE easing bias.” They decided against it at the time but this revelation confirms that the central bank is getting ready to taper asset purchases. Even ECB member and Bundesbank President Weidmann agreed that the recovery opens the door to ECB policy normalization and Nowotny added that QE is not a permanent policy tool. We often see this type of uniformity in the central bank’s comments when it wants to prepare markets for a major change in policy and that’s exactly what we think the ECB is doing. As such, we continue to expect euro to outperform other currencies, particularly sterling, Australian and New Zealand dollars. German industrial-production numbers are on Friday and the increase in factory orders points to another euro-positive report.
Sterling also rebounded on the back of hawkish comments from Bank of England member McCafferty, who said inflation has picked up very rapidly and the pound is firming investment. He described the currency's recent rise as small, saying that generally speaking, the currency is helping exporters. As a result, McCafferty believes that a couple of rate rises may be necessary in the coming years if the central bank’s forecasts pan out. McCafferty joins a handful of BoE officials who have started to pound the table about rate increases. Unfortunately, recent economic reports have been weak, raising questions as to how quickly the central bank could tighten. The country’s industrial production and trade balance are scheduled for release Friday and while 1.30 may not be far away, we don’t see a sustained break of this level unless the U.S. Nonfarm Payrolls report is very weak.
Friday is also a big day for the Canadian dollar, which resumed its rise versus the greenback. An unexpectedly large increase in building permits contributed to the move along with a small uptick in oil prices. Unfortunately, the country’s trade deficit nearly doubled in May, which was a surprise as economists anticipated a narrower balance. Thankfully, both imports and exports increased, which is a sign of strength for Canada’s economy. The country’s labor market and IVEY PMI reports are scheduled for release Friday. While these numbers will take a backseat to U.S. payrolls, we will still see a meaningful reaction in CAD as these reports shape expectations for next week’s Bank of Canada monetary policy announcement. Although we think the labor market and manufacturing sectors are performing well, we could see a pullback after last month’s strong reports, which could trigger profit taking in USD/CAD. The Australian and New Zealand dollars were among the day’s worst performers but their weakness had little to do with data, especially since Australia reported a significantly larger-than-anticipated trade surplus in May. Instead, both currencies have found resistance after last month’s strong gains and are being dragged lower by profit taking, risk aversion and the decline in U.S. stocks. We continue to expect these currencies to underperform as the hawkishness from other central banks make AUD and NZD less attractive.