By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
Friday's extraordinarily weak nonfarm payrolls report sent the U.S. dollar tumbling against all of the major currencies. We haven't seen a move this strong in 2 months for EUR/USD and it's been more than a month for USD/JPY. The 2-year Treasury yield dropped by the largest amount since March 2009 and Fed Fund futures are now only pricing in a 29% chance of tightening in July -- down from more than 50% pre-NFP. A mere 38K jobs were created in May, the weakest since September 2010 and while the data is distorted by the Verizon (NYSE:VZ) strike, even if you add back the 35K jobs lost, the number was still terrible. The unemployment rate hit its lowest level since 2007 but the improvement was driven by a drop in the participation rate. Average hourly earnings growth eased to 0.2% from 0.3%. The softness of Friday's report caused the market to downgrade its expectations for a summer rate hike and the question now is how that affects Janet Yellen's thinking. She was unabashedly hawkish last month when she said a rate hike might be appropriate in the coming months. If she repeats that view -- and she could due to the consistency of comments from U.S. policymakers and their overall view that the labor market is doing well -- the dollar will rebound. But don't expect the greenback to recapture all of Friday's moves. Significant technical damage was done and the weakness of Friday's report will have investors eyeing every positive comment from Yellen with skepticism. In addition to the soft labor data, service-sector activity also slowed. There are very few pieces of market-moving U.S. economic reports on next week's calendar, but even if there were, Yellen is the one to watch as her comments frequently sets the tone for trading, which is now truer than ever.
Euro Soars on NFPs, ECB in Wait and See Mode
After consolidating for more than a week, the soft nonfarm payrolls report drove the EUR/USD out of its 1.0950 to 1.1250 trading range. However for the Eurozone, the ECB monetary policy meeting was the main focus and investors were unimpressed by the Mario Draghi who had nothing new to say on monetary policy. The central bank increased its growth and inflation outlook but Draghi spent a greater portion of his press conference emphasizing ECB's willingness to increase stimulus if financial conditions tighten significantly. Like the Fed, the ECB is waiting for the results of the U.K. referendum before deciding what steps to take next. The bank is comfortable with the current level of monetary policy and expects corporate-bond purchases (set to start on June 8 and TLTRO, which begins June 22) to provide additional support for the economy. Looking ahead, Mario Draghi will be speaking again on Thursday, revisions to Eurozone GDP is scheduled for release and from Germany we have factory orders, industrial production and the trade balance. Considering that we just heard from the ECB head, none of these event risks is likely to be big market movers for the euro.
GBP: Brexit Trumps All
For the past few months, sterling completely shrugged off economic data. The currency soared in May despite weaker PMI numbers and this month it plunged even though manufacturing and service-sector activity beat expectations to rise at a faster pace. And the reason is simple -- Brexit trumps all. The performance of the British pound has been driven entirely by Brexit polls and the same is expected in the coming week with only industrial production and the trade balance scheduled for release. The U.K. referendum is only 3 weeks away, which means investors will be laser focused on Brexit polls. To this day, the polls are close, with some reporting more Britons in favor of remaining in the European Union while others seem to favor an exit. Leaving the EU poses a significant risk for the financial markets and could mean a period of deep economic uncertainty that will hurt consumer, business and investor confidence, ultimately translating into weaker headline growth. Some even argue that it could drive the U.K. into recession. There could be significant costs for trade, investment and jobs if the U.K. fails to strike a trade deal with the EU and U.S. The stakes are high and that's why every time a politician warns about the consequences of Brexit, sterling rises as investors view it as another reason for the British to remain in the Union. Keep an eye on the polls because they will dictate how sterling trades on a day-to-day basis next week.
USD/CAD Tanks But Oil Remains Weak
When it comes to the Canadian dollar, there's nothing more important than oil. For the past week, oil prices struggled to break above $50 a barrel, and that resistance translated into steady gains for USD/CAD. However Friday's soft U.S. labor-market report and stronger Canadian trade data took USD/CAD back to the bottom of its range. OPEC's decision to leave production levels unchanged put a cap on oil prices and even with the decline in Friday's dollar, crude failed to rise. However with USD/CAD's decline stopping right at the 50-day SMA, we are now looking for a bounce back to 1.3000. USD/CAD will remain in focus next week with Canada's IVEY PMI and employment report scheduled for release. These are tier-one economic releases that tend to have a significant impact on the currency and will help determine whether USD/CAD clears 1.3000 or breaks 1.29.
AUD Soars Above 200-day SMA
Both the Australian and New Zealand dollars ended the week sharply higher against the greenback. While NZD showed steady performance, all of AUD's gains came on Friday after the abysmal nonfarm payrolls report. This week's Australian economic reports were mixed with the PMI services index rising while the manufacturing index fell. GDP growth was very strong in Q1 but consumer spending growth is slowing. These mixed reports will give the Reserve Bank strong reasons to leave monetary policy unchanged next week. However the minutes from the last RBA meeting indicated that the decision was a close one, so the tone of the RBA statement could be slightly less dovish. The outperformance of the New Zealand dollar can be credited to the uptick in dairy prices but dovish comments from RBNZ Governor Wheeler in the coming week could strip the pair of its gains. When the RBNZ met last month, it maintained a dovish bias, saying that further policy easing may be required and that a lower New Zealand dollar is desirable. Since then, there has been very little reason for their views to change. China's trade balance is also scheduled for release and the outcome of the report will affect all 3 commodity currencies.