By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
Many investors were confused by the dollar's lackluster reaction to Friday morning's nonfarm payrolls report. Job growth was very strong with payrolls rising 211k, the unemployment rate held steady, average hourly earnings rose 0.2% and the participation rate ticked higher. The dollar should have held on to its initial gains because the data guarantees that the Fed will raise interest rates this month. But crowded trades got killed this week. The ECB cut interest rates, extended its QE program and the EUR/USD rallied. Yellen warned that delaying a rate hike is a risk and NFPs were strong -- but still, the USD barely rallied. While it may be difficult to remain confident in our views that USD/JPY will break 124 and EUR/USD will drop back below 1.08, the fundamentals remain intact.
Let's take a step back and assess recent developments in the market -- the ECB eased and the Fed is poised to tighten. While many investors have discounted these moves, the recent recovery in EUR/USD leaves new traders on the sidelines ready to jump back in. There's still 8 trading days before FOMC and while we do not anticipate a large 2-to-3 big-figure move in the USD versus EUR or JPY pre-FOMC, we believe that it could rise another 100 to 150 pips from here. Taking an even larger step back, while the Fed will go to great lengths to downplay liftoff this month, it will still be raising interest rates by another 50 to 75bp next year. During this time, the ECB will keep buying bonds and maybe even increase asset purchases further.
ECB officials were not happy with the euro's reaction to Thursday's decision. ECB member Constacio was the first to say that the markets got the ECB's message wrong and later Friday morning, ECB President Mario Draghi said ECB would deploy further tools if necessary in order to reach the inflation goal without delay. He also said QE is there to stay and can be recalibrated if needed and there is no specific limit to the balance sheet. A rising euro diminishes the effectiveness of ECB stimulus. The amount of easing they provided this week may have been sufficient with EUR/USD at 1.05, but at 1.10 or higher -- equating to a 5% stronger exchange rate -- they may need to do more. 1.10 may not be a big concern, but if EUR/USD breaks 1.12 and has 1.15 in sight, then European policymakers are likely to come out in force to talk down the euro.
OPEC was also a big story on Friday. With oil prices hovering near $40 a barrel, many analysts hoped they would cut production, creating in bottom in crude. But then rumors started to circulate that they had decided to 'officially' increase production. However instead of choosing any of these options they decided to leave numbers out of the official communique. All of these headlines created significant volatility for oil. While the number is largely symbolic because members have been pumping out oil at near record levels for months, the decision to leave it out keeps the market guessing on output changes, which is neither good for oil nor global inflation pressures.
USD/CAD did not benefit from stronger U.S. payrolls and lower oil prices. This price action cannot be easily attributed to data because Friday morning's reports were mixed. Canada reported stronger IVEY PMI but the trade deficit ballooned and more than -35k jobs were lost compared to the market's -10k forecast. While all of the jobs shed were part time and full time employment increased, the unemployment rate rose to 7.1% from 7% and the participation rate dropped to 65.8 form 66. Collectively, OPEC's decision, the move in oil, U.S. and Canadian data all point to further gains for USD/CAD.
There was very little movement in sterling but the Australian and New Zealand dollars traded sharply higher. In fact of the majors, NZD/USD was the best performer. What's interesting about this move is that NZ commodity prices dropped a whopping 5.6% in November and U.S. payrolls were strong. Counterintuitive price action was clearly the day's theme. The Reserve Bank of New Zealand meets next week and economists are looking for another 25bp rate cut. If they are right, then NZD should find resistance quickly and start to move back toward 66 cents. The move in the Australian dollar on the other hand was supported by stronger data and higher commodity prices. Australian retail sales rose 0.5% in October. Australian employment numbers are scheduled for release next week and unfortunately slightly weaker numbers are anticipated.
Aside from the RBNZ, the SNB and BoE also have monetary policy announcements. For the dollar, the main focus will be China's trade-balance numbers and the U.S. retail-sales report.