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USD: More QE Depends on NFP

Last updated 9/2/2010 4:36 PM ET (GMT -5) 2 Comments

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Kathy Lien

Director of Currency Research, GFT

THE STORIES IN THE CURRENCY MARKET

• USD: MORE QE DEPENDS ON NFP
• EUR: ECB UPGRADES GDP FORECASTS, BUT EXTENDS EMERGENCY LENDING
• GBP: PRESSURED BY WEAKER HOUSING DATA
• AUD: SHRUGS OFF PULLBACK IN TRADE
• CAD: OIL AND GOLD PRICES REBOUND
• NZD: EXTENDS GAINS AGAINST USD
• JPY: WHY THE YEN HAS BECOME POLITICAL

EXPECTATIONS FOR UPCOMING FED MEETINGS

USD: MORE QE DEPENDS ON NFP

Currencies and equities have consolidated ahead of Friday’s non-farm payrolls report with the dollar trading slightly lower indicating that investors are bracing for a softer report. Whether or not payrolls surprise to the downside remains to be seen but the squaring of long dollar positions ahead of this release is smart considering the volatility that is expected to be triggered by the report. Of all the economic indicators that investors follow, NFPs is one, if not the most market moving release. Non-farm payrolls measure the changes in the American workforce which has significant implications for the U.S. economy because it directly impacts consumer spending, the profitability of U.S. corporations and in turn, overall growth for the nation. This is why the Federal Reserve will be watching the report closely to see if more Quantitative Easing is needed to stimulate the economy. Ahead of this key release, the dollar traded lower against the euro, Japanese Yen, Swiss Franc, Australian and New Zealand dollars. The only currencies that weakened more than the euro were the British pound and Canadian dollars. 

Leading Indicators for NFPs Point to Positive Private Sector Payrolls

At Jackson Hole last month, Chairman Bernanke said the central bank stands ready to act if needed, which means that they are considering additional Quantitative Easing. If non-farm payrolls beat expectations, it would reduce the need for more QE but if the labor market report disappoints, it could force the Federal Reserve into action. Every month we attempt to predict the direction of non-farm payrolls by taking a look at a hearty list of labor market reports that are released before NFPs. This month, most of the leading indicators that we follow for non-farm payrolls points to stronger private sector payrolls growth in the month of August.  Every so often we are left without our most reliable indicator for payrolls, which is the service sector PMI report and unfortunately this is one of those months. Over the past 30 days, consumer confidence has improved, the manufacturing sector added jobs at its fastest pace ever while Challenger Grey & Christmas reported a 54.5 percent drop in job cuts in the month of August than brought total layoffs to the lowest level in more than decade. Although jobless claims have increased and the ADP report showed net job losses, the following chart indicates that ADP oftentimes undershoots private sector payrolls. In November 2009 and January 2010 for example, private sector payrolls increased even though ADP printed negative. However a stronger payrolls report is not the same as positive payrolls. Non-farm payrolls are simply expected to fall by a smaller amount while private sector payrolls are expected grow but in no way will these numbers be characteristic of a strong labor market report. 

Of the -100k job losses forecasted for August, the majority will be in government jobs which is why the private sector payrolls report will receive just as much, if not more attention that the headline release which will provide the net change in non-farm payrolls. The Census jobs were meant to be temporary and the planned layoffs have already been discounted by the market. Investors could react to the payrolls report in many different ways but here are the 5 most likely scenarios:

Given the significance of the non-farm payrolls report, it will only be a quiet day in the forex market if both non-farm payrolls and the private sector payrolls report meet expectations to the T. However in all likelihood that would probably not be the case since the range of forecasts are so wide. Therefore the biggest shock would come from a positive non-farm payrolls report accompanied with strong additions in the private sector, which could trigger a sharp rally in the U.S. dollar. If overall job growth meets expectations but private sector job growth misses, the impact on the dollar will depend on the size of the disappointment. Private sector job growth of less than 30k would probably be very bearish for the U.S. dollar while job growth closer to 40k should only elicit a small reaction. Should the change in non-farm payrolls and private sector payrolls both disappoint, the impact on the dollar would be far more significant and would likely cause the greenback to sell off aggressively if the print is weak enough. If non-farm payrolls beat expectations but private sector payrolls fall short, the private sector number would undoubtedly overshadow the net change non-farm payrolls.  As usual, USD/JPY will have the cleanest reaction to the non-farm payrolls report while high beta currency pairs such as the EUR/USD, GBP/USD and AUD/USD will respond to risk appetite. Be forewarned however as Non-farm payrolls are a notoriously volatile piece of data to trade as revisions and expectations can also impact the market’s reaction. 

Aside from payrolls, service sector ISM is also scheduled for release and given the uptick in manufacturing activity along with the pickup in retail sales, the odds favor a stronger release. 

EUR: ECB UPGRADES GDP FORECASTS, BUT EXTENDS EMERGENCY LENDING

After all of the volatility in the euro during ECB President Trichet’s press conference, the single currency ended the day virtually unchanged against the U.S. dollar. As expected, the central bank left rates unchanged at 1 percent and based upon Trichet’s comments, they intend to maintain an easy monetary policy and have no plans to raise rates in the near future. Although they recognize the improvements in economic data, they believe that it will be temporary which is why the central bank upgraded their GDP and inflation forecasts and emergency lending measures for banks at the same time. The risks to the economic outlook are on the downside due to the emergence of renewed tensions in the financial markets, uncertainty in other markets, the recent increases in oil prices and the risk of a disorderly correction of global imbalances.  Higher energy prices also contributed to their upgraded inflation forecasts and as a result, the ECB remains "cautious and prudent." In general, they expect the economy to grow at a moderate pace and for price stability should remain contained. On the U.S. economy, he is not "too disappointed" by the developments in the U.S. and shares Bernanke's analysis (in other words pessimistic) outlook on the U.S. economy.  Compared to the Federal Reserve, the ECB's tone was more upbeat and it is clear the central bank is still a step ahead of the Fed when it comes to normalizing monetary policy.  The Fed's last decision represented a step back to monetary easing whereas the ECB continues to move forward by withdrawing emergency measures. In terms of economic data, the latest numbers show the Eurozone economy expanding by 1 percent in the second quarter and producer prices growing by 0.2 percent in the month of July. Eurozone retail sales are scheduled for release tomorrow and a weaker report can dampen the euro ahead of NFPs. Meanwhile in Switzerland, consumer spending in July was very strong. Retail sales jumped 4.8 percent on the heels of a strengthening recovery and falling unemployment. The economy as a whole is also doing very well with the GDP rising by 0.9 percent in the second quarter to a year over year rate of 3.4 percent. Stronger investment spending along with a rapidly improving economy reduces the need for the Swiss National Bank to intervene in the Franc and increases the need for a rate hike more normal levels of monetary policy. Consumer prices are scheduled for release tomorrow and inflationary pressures are expected to be muted. 

GBP: PRESSURED BY WEAKER HOUSING DATA

The British pound was one of only 2 currencies that underperformed the U.S. dollar today. Unlike the Eurozone which had neutral economic data, disappointments and softer releases continue to come out of the U.K. According to the Nationwide Building Society, house prices fell 0.9 percent in August, the most in six months. Despite ultra low interest rates, the U.K. housing market has had a very tough time recovering as increased supply gave buyers more bargaining power. The improvement in the economy has encouraged more sellers to come back into the market which has in turn made buyers more price sensitive. At the same time, credit is still very difficult to attain. The softness of the market also explains why construction sector activity continued to slow. The construction PMI index fell from 54.1 to a four month low of 52.1. Service sector PMI is scheduled for release tomorrow and the disappointments in manufacturing and construction sector activity puts in the odds in favor of a softer release.  However considering that consumer confidence increased in the month of August according to GfK, the service sector may not have suffered as sharp of a decline in activity as the manufacturing sector. Today’s weaker economic reports pushed the British pound within a whisker of its one month low against the euro. Although the GBP/USD also remains very weak, it is prime for a breakout and tomorrow’s PMI and NFP reports could be just the right mix of data to encourage such the move.

AUD: SHRUGS OFF PULLBACK IN TRADE

The Australian and New Zealand dollars managed to extend their gains against the greenback but the Canadian dollar retreated despite a rise in oil prices.  Australia was the only country to release economic data over the past 24 hours and despite a softer report that showed the Australian trade surplus shrinking, the Aussie still managed to end the day higher. Rising imports and declining exports of coal and iron ore narrowed the trade surplus from AUD3.44 billion to AUD1.89 billion in the month of July. Considering that Australia is riding on the coattails of China vis a vis trade activities, the softer release should have drive the Aussie lower and it did for a short period of time. However once London traders joined the market, the currency was bid up once again. Compared to the rest of the world, the Australian economy is doing well even if manufacturing activity is slowing. This evening, we will get to see how the service sector has been performing with PMI services scheduled for release. The sharp rise in retail sales suggests that the service sector may not have fallen victim to the same fate as the manufacturing sector. At the same time, don’t forget that Australia is still in a political deadlock with Gillard and Abbott battling for the job of Prime Minister. In the latest development, current Prime Minister Gillard has won the support of a key independent Member of Parliament (MP), putting her one step closer to securing her seat. With the deadlock being drawn out for such a long period of time, the markets may cheer a winner, regardless of who it is. 

JPY: WHY THE YEN HAS BECOME POLITICAL

The Japanese Yen strengthened against most of the major currencies except for the New Zealand dollar and Swiss Franc. There was no major economic data out of Japan but the back and forth between Prime Minister Kan and PM Candidate Ozawa continues to dominate the headlines. Ozawa has repeated his calls for the Japanese government to stop the yen from rising but in an interesting twist, he said “there are other steps than yen selling intervention to stem the yen’s rise.” He acknowledged that FX intervention by Japan alone may not have much effect on the currency, but the Bank of Japan should still be prepared to act. It certainly seems that the Yen will be a central focus in this month’s election and it is important because it directly impacts the competitiveness of Japanese exporters. Today’s NY Times carries an interesting article about how the strong yen has benefitted foreign companies at the expense of Japanese ones . Kuka, a company based in Germany that makes industrial robots used on auto assembly lines have seen their sales bounce back to precrisis levels and “then some. By contrast, sales at its Japanese rivals were still one-third below where they stood in early 2008.” The weakness of the euro compared to the Yen has given Kuka a major price advantage. Since the beginning of the year, EUR/JPY has fallen more than 18 percent in value which makes Kuka’s robots much cheaper due simply because of foreign exchange fluctuations. According to research by Allianz, the German insurer, “the dollar’s rise against the euro has added three or four percentage points to German exports, while the yen’s rise has added no more than one percentage point.” This helps to explain why the value of the Yen is a very strong political platform for Ozawa to run on.

USD/JPY: Currency in Play for Next 24 Hours

USD/JPY will be the currency pair in play tomorrow with U.S. non-farm payrolls scheduled for release at 8:30am NY Time or 12:30 GMT followed by the ISM non-manufacturing report at 10:00am NY Time or 14:00 GMT. 

For the past 4 months, USD/JPY has been trading in a very strong downtrend and so far, there are few signs that the trend has exhausted. The currency pair is currently trading in the downtrend zone, which we determine using Bollinger Bands. The 85 level is the closest level of resistance but a move above 87.50 is needed to negate the downtrend. In terms of support, the closest is the 15 year low of 83.59. If that level is broken, then there is no major support until the April 1995 low of 79.75.

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Comments (2)

fxfundamentals

September 02, 2010 at 05:19 PM ET

kathy if numbers are better than expecting will the dollar rally againist the euro, thanks for all you do for the retail investor

Euro

September 03, 2010 at 12:48 AM ET

Hi Kathy, what is the meaning of "Quantitative Easing"?

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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.