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THE STORIES IN THE CURRENCY MARKET

• U.S. DOLLAR: UNEVEN RECOVERY
• EUR/USD: ECB TAKES FIRST STEP
• GBP/USD: SERVICE SECTOR PMI MISSES
• USD/CAD: EMPLOYMENT AND IVEY PMI ON TAP
• AUD/USD: SERVICE ACTIVITY SLOWS, RETAIL SALES RISE
• NZD/USD: GOLD AND OIL PRICES LOWER
• USD/JPY: BOUNCES ON INTERVENTION FEARS

EXPECTATIONS FOR UPCOMING FED MEETINGS

CURRENT US INTEREST RATE: 0.25%
	12/16 Meeting	1/27 Meeting
NO CHANGE	59.6%	58.4%
Cut to 0.00%	40.4%	37.8%
Increase to 0.50%	0.0%	3.8%
Increase to 0.75%	0.0%	0.0%

U.S. DOLLAR: UNEVEN RECOVERY

It has been a mixed day in the currency markets with the U.S. dollar trading lower against the euro, Australian and New Zealand dollars but higher against the British pound, Japanese Yen and Canadian dollar. Stocks were unchanged for most of the day but in the last half hour of trading, they plummeted as traders took profits ahead of Friday’s non-farm payrolls report (NFP). Consolidative price action is not uncommon before NFP, which is the most market moving event risk for the currency market because the labor market is the backbone of the U.S. economy and jobs are critical to the U.S. recovery. The price action even suggests that traders are in denial about the sharp decline in non-manufacturing ISM because they are holding onto the hope that job losses are receding.

How Significant is the Decline in Service Sector ISM?

However the non-manufacturing ISM report is very important because the service sector accounts for almost 90 percent of the U.S. economy. The drop from 50.6 in October to 48.7 in November propels the sector back into contractionary territory. Although this is discouraging, it is not completely surprising since the pace of recovery in the U.S. economy has slowed. Also, during the 2001 recession, the service sector oscillated in between expansionary and contractionary conditions. Yet the details of the report were not nearly as discouraging as the headline release. There was only a modest decline in new orders and actually an increase in export orders and a slower contraction in employment. At this point, the manufacturing sector is outperforming the service sector thanks to a weaker dollar but if the financial sector continues to improve, the service sector could catch up. The non-manufacturing ISM report is a fairly important barometer of the overall U.S. economy but its most practical usage is to help predict the directional move in non-farm payrolls. In our November Non-Farm Payrolls Preview , we included a chart illustrating the strong correlation between the employment component of service sector ISM and NFP - the 0.5 increase in the employment component signals only a marginal improvement in the payrolls report.

What to Expect from Non-Farm Payrolls

The bar is set high for Friday’s non-farm payrolls report as the market expects the smallest amount of job losses in 25 months. The consensus forecast calls for non-farm payrolls to fall by 125k, but actual economist forecasts range anywhere from -30k to -185k. Of the 9 leading indicators of non-farm payrolls that we typically follow, 7 point to a strong number. However 3 of the most important (service ISM, ADP and Consumer Confidence) only rose modestly which is why we believe that the improvement in payrolls could be small. In fact, we would not be surprised if non-farm payrolls fell by more than 150k in the month of November because the only unambiguously positive improvement was in jobless claims. This means that as usual, the only thing that we can be certain of when it comes to the market’s reaction to NFP is volatility because given the wide range of forecasts someone is bound to be surprised. The jobless rate will also be important now that it has breached the 10 percent mark because if it falls, everyone will begin to wonder if unemployment has finally peaked. Read our NFP Preview for more on How the EUR/USD could react to Non-Farm Payrolls.

How do Obama, Geithner and Bernanke Feel?

On the eve of the jobs report, President Obama held a Jobs Summit. Conspiracy theorists may wonder if this is damage control before an ugly number is released but we won’t speculate on that because the goal of the Summit is to let America know that job creation is a top priority for the Obama Administration. He called on the nation’s largest companies to “bring their A-game” in presenting new ideas for job creation. In an interview with CNBC, Treasury Secretary Geithner echoed Obama’s commitment to job creation. He also indicated that it is vital to bring down the U.S. budget deficit and for the government to persuade the world that it will be more fiscally responsible in the future. In his confirmation hearing, Federal Reserve Chairman Ben Bernanke defended the Fed’s role in bailing out financial firms and indicated that their job is far from complete. He has received a lot of criticism and if he not confirmed by the Senate Banking Committee for a second term as the head of the central bank, expect the U.S. dollar to sell off aggressively.

EUR/USD: ECB TAKES FIRST STEP

The European Central Bank took its first steps to scale back emergency measures this morning when Trichet announced that they will terminate the one year tender in December and that the final tender will be offered at a rate based upon the average policy rate over the coming year and not a fixed rate of 1 percent. They also announced that the 6 month tender will end on March 31st and that unlimited funds will only be available until April 13th. In other words, they are cutting their monetary stimulus programs, an unambiguously hawkish. Yet even though the EUR/USD initially rallied on the announcement, it failed to hold onto its gains because Trichet pledged to provide abundant liquidity for the first 3 months of 2010 which implies that they are still a long way from raising interest rates. The central bank head went out of his way to stress that phasing out lending measures does not represent policy tightening and that it is very important not to signal anything on rates. The latest growth and inflation forecasts indicate that the ECB no longer expects the economy to contract in 2010. Eurozone retail sales, GDP and PMI numbers were mostly in line expectations. There are no European economic data due for release tomorrow which means that the price action of the EUR/USD will be determined by the NFP numbers. From a longer term perspective, the action by the ECB and the trend of European economic data compared to the trend of U.S. data supports further gains in the EUR/USD.

GBP/USD: SERVICE SECTOR PMI MISSES

After rallying against the U.S. dollar for two days in a row, the British pound sold off on the heels of a weaker than expected service sector PMI report. The sharp divergence in price action between the euro and British pound has caused outsized moves in EUR/GBP over the past few trading days. Service sector activity slowed in the month of November with the PMI index falling from 56.9 to 56.6. Although the drop was marginal, the market was actually looking for a rise. Of the 3 sectors in the U.K. economy, manufacturing and service activity slowed last month while construction activity increased. The housing market has been the most resilient part of the U.K. economy. Even though growth in manufacturing and services slowed, both sectors are still expanding. Like the U.S. non-manufacturing ISM report, the guts of the U.K. report were not as negative as the headline release. New business rose for the fourth month in a row and the rate of job losses was the smallest since September 2008. This of course does not draw away from the fact that the Bank of England still believes the economy could use more stimulus. Until they shift their stance, the GBP/USD may have a tough time rallying.

USD/CAD: EMPLOYMENT AND IVEY PMI ON TAP

Having traded higher against the U.S. dollar for most of the NY Trading session, the Canadian, Australian and New Zealand dollars gave back their gains when the sell-off in U.S. stocks accelerated. Although the U.S. non-farm payrolls report is the marquee event on the economic calendar tomorrow, it will also be a big day for Canada who also has its employment report due for release along with IVEY PMI. After sharp job losses in October, job growth is expected for November. However any positive sentiment in the loonie could be eroded by weak IVEY PMI numbers. There was no economic data from New Zealand but mixed numbers came out of Australia last night - Service sector PMI fell from 54.8 to 52.5 in November while retail sales rose 0.3 percent in October. Although the Australian economy is still doing very well, they are not vulnerable to slowdown in the global recovery. The recent rate hikes could also negatively affect growth in the coming months.

USD/JPY: BOUNCES ON INTERVENTION FEARS

For the third day in a row, the Japanese Yen extended its losses against the U.S. Dollar, British Pound, and Euro. Fears of intervention by the Japanese government is still pushing the Yen lower. Final GDP numbers which are due for release next Tuesday will probably indicate that the economy grew by 0.7% in the third quarter compared to an initial forecast of 1.2 percent as companies cut spending amid slower domestic demand. The fears of stagflation, which is a deflationary period encompassed with negative economic growth, are beginning to emerge. The Ministry of Finance reported a drop of capital spending by 24.8% in all categories, which is the second steepest drop on record, while manufacturing spending fell a record 40.7%. Specifically, the MOF noted “Companies continued to shed underutilized plant and equipment as anemic domestic demand, the yen's appreciation and falling prices depressed sales.” According to Nikkei Business Daily, tapanese officials are planning to start additional stimulus measures immediately in the amount of ¥4 Trillion from proposed ¥20 Trillion or $230 Billion. The following conditions seem problematic as Japanese credit rating is already on watch by several rating agencies. Japan does not expect any economic releases until the following week; the Yen will be guided by risk appetite/aversion flows until then.

USD/CAD: Currency in Play for Next 24 Hours

For the next 24 hours, USD/CAD will be the currency in play. Canadian employment figures are expected to be released at 12:00GMT or 7:00AM EST followed by IVEY PMI numbers at 15:00 GMT or 10:00 EST. The U.S. will announce the anticipated Non-Farm Payrolls at 13:30GMT or 8:30AM EST. USD/CAD is currently trading in the Range Trading Zone which we determine through the use of Bollinger Bands. Weak economic data could drive the currency pair above 1.0620 which would take it into the Buy Zone. Given that USD/CAD has been carving out a triangle formation a break of 1.0720 would open the door for a move to 1.10. However if data is good or USD/CAD sells off in reaction to the U.S. nonfarm payrolls number, a drop below 1.04 leaves the next level of support at 1.02.

About The Author

Kathy Lien began her FX trading career 10 years ago at J.P. Morgan Chase. After graduating New York University’s Leonard Stern School of Business at the age of 18, Kathy joined the bank's interbank FX trading desk and eventually moved to the cross markets proprietary trading desk. In the interbank market, her ability to create solid fundamental and technical analysis from the myriad of information on the market helped her trade forex spot and options. Her experience eventually led her to be chief strategist at Daily FX where she worked until she joined GFT in 2008.

With her knowledge of forex, as well as her experience trading other products, such as interest rate derivates, bonds, equities, and futures, Lien has built a reputation as an international currency analyst. She is frequently quoted on CNBC, Bloomberg, Fox Business and Reuters. Lien has also written for publications like Active Trader, Futures, and SFO magazine. She is the author of the newly updated Day Trading the Currency Market: Technical and Fundamental Strategies to Profit from Market Moves, and the co-author of Millionaire Traders: How Everyday People Are Beating Wall Street at Its Own Game with Boris Schlossberg.

To buy Kathy’s newly updated Day Trading and Swing Trading the Currency Market: Technical and Fundamental Strategies to Profit from Market Moves, click here.