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USD: Risk Rally Fizzles, Help From NFP?

Last updated 12/1/2011 4:36 PM ET (GMT -5) 0 Comments - Add your comment

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Kathy Lien

Director of Currency Research, GFT

THE STORIES IN THE CURRENCY MARKET

• USD: RISK RALLY FIZZLES, HELP FROM NFP?
• EUR: HELPED BY DECLINE IN YIELDS, CHF INTERVENTION?
• GBP: MANUFACTURING PMI LOWEST SINCE JUNE 2009
• CAD: REBOUND EXPECTED IN LABOR MARKET
• AUD: SLOWER CONSUMER SPENDING
• NZD: HIT BY WEAKER CHINESE DATA
• JPY: DATA SHOWS MORE INTERVENTION IN NOV

EXPECTATIONS FOR UPCOMING FED MEETINGS

USD: RISK RALLY FIZZLES, HELP FROM NFP?

Considering the significance of the coordinated action by central banks on Wednesday, the fact that yesterday’s momentum failed to carry over today is simply disappointing and reinforces our warning that although helpful, more liquidity does not solve the structural problems in the Eurozone. It is now widely believed that the only reason why the most powerful central banks in the world opened up the spigots was because a major European bank was at the brink of failure. This of course will never be verified but it is yet another reason why we believe that their actions so far are not enough to put an end to Europe’s crisis. The sustainability of the recovery in risk will now hinge upon the European Central Bank and EU Leaders meetings next week. In the meantime however, U.S. economic data will provide a bit of distraction. The November non-farm payrolls report will be released on Friday and all signs point to stronger job growth. In October, 80k jobs were created and for November, economists expect this number to rise to 125k. Job cuts in the public sector will be made up by job growth in the private sector. All but one of the leading indicators for payrolls that we use to forecast the direction of non-farm payrolls points to more job creation.

Private sector payroll provider ADP for example reported an increase of 206k jobs last month, a nice improvement from the 130k jobs added by U.S. companies in October. ADP has not been the perfect leading indicator for NFPs, but given the consistency of other labor market reports there is a good chance that the increase in job growth reported by ADP will carry through to NFPs. For the past 4 weeks, weekly jobless claims were at or below 400k and for this reason the four week moving average is also below 400k for the first time since April. Perhaps the improvement in consumer confidence can be explained by the improvement in the labor market. Both the University of Michigan and Conference Board reports increased in the month of November while Challenger Grey & Christmas reported a 13 percent decline in layoffs. The only indicator that suggests slower job growth was the employment component of manufacturing ISM which fell from 53.5 to 51.8. A good non-farm payrolls report will be a step towards recovery but Federal Reserve officials will continue to have their reservations until there is a credible solution to Europe’s debt crisis. Jobs have long been the missing ingredient in the U.S. recovery and for the time being, job growth has not been consistently strong enough to make a big dent into the unemployment rate. With Europe expected to remain in the midst of crisis in the New Year, the U.S. could still see slower growth which is why QE3 is not off the table. Nonetheless, a strong non-farm payrolls report will be something to celebrate, especially on the heels of the coordinated increase in liquidity provided by central banks this week.

Fed President Bullard commented on yesterday’s actions, saying that he supported the decision on dollar swaps and if needed, liquidity facilities could be reopened. Like many central bankers, he realizes that Europe’s problems will not go away quickly and unlikely to be solved by a “silver bullet.” He is not a voting member of the FOMC but he opposes having a monetary policy pledge based on a set date like the one currently in the FOMC statement. The last time the Fed met, they repeated a line added back in August that said economic conditions “are likely to warrant exceptionally low levels for the federal funds rate at least through mid-2013.”

EUR: HELPED BY DECLINE IN YIELDS, CHF INTERVENTION?

The euro held onto its gains against the U.S. dollar but failed to extend the rally on Day 2 of the central bank’s liquidity action. We were immediately skeptical of the effectiveness of the central bank’s actions and the price action in the euro today confirms that many investors feel the same way. The Eurogroup and ECOFIN meetings have passed with no surprises and now it will be up to EU Leaders to deliver enough progress to prevent the EUR/USD from slipping back to 1.32. Two important things that the dollar swap rate cut and extensions have done are lower bond yields throughout Europe and boost investor confidence. German, French, Italian and Spain bond yields fell significantly today thanks in part to solid bond auctions in France in Spain. French bond yields fell 30bp which was the largest one day decline since 1991. Both countries had no problems selling their bonds with high bid to cover ratios that indicate they were able to attract significant demand. The yields were higher than prior auctions, but lower than the secondary market levels before the sale. The successful auction drove the EUR/USD above 1.3520 but the rally fizzled after ECB President Mario Draghi hinted that the central bank could do more to support the region. He said first and foremost a “new fiscal compact” is needed to “start restoring credibility,” “other elements may follow, but the sequencing matters.” The ECB is widely expected to cut interest rates on December 8th but with EU Leaders meeting beginning that day, it is not clear whether the “other elements” he is talking about refers to lowering rates or more ECB involvement. Semantics aside, the ECB needs to cut interest rates and will do so quickly particularly since they believe there is significant downside risks to their economic outlook. Draghi indicates that the next few days will be very important for the euro area and we certainly agree because the actions of the ECB and EU Leaders could determine how the EUR/USD trades for the rest of the year. Meanwhile in this morning’s Eurozone economic reports, French PMI Manufacturing was revised down slightly while Italian PMI Manufacturing was revised up slightly. German and Eurozone numbers remained unchanged, reflecting broad based contraction in activity during the month of November. The Swiss Franc also weakened against the euro and U.S. dollar following softer economic data. GDP growth in the third quarter slowed to 0.2 percent from 0.5 percent which pushes the annualized pace of growth down to 1.3 percent, the slowest since the fourth quarter of 2009. On an intraday basis, there was quite a bit of volatility in the Swissie which fell sharply around the European close. This price action suggests that the Swiss National Bank may have been in the market selling Francs.  There is also a rumor that the Swiss National Bank is considering negative interest rates, but we won’t know whether this is true until their next monetary policy meeting on December 15 ^th .

GBP: MANUFACTURING PMI LOWEST SINCE JUNE 2009

The British pound held steady against the U.S. dollar and continued to consolidate against the euro as investors realized that what is positive or negative for the euro will have the same effect on the pound. U.K. manufacturing activity contracted at its fastest pace in 2.5 years last month due to weaker domestic and external demand. The manufacturing PMI index fell for the fourth time in five months with the index slipping from 47.8 to 47.6. The details of the report from Markit/CIPS Economics showed weaker output, further job losses and the first decline in input prices since July 2009. New orders also fell for the fifth month in a row while new export orders were hit by weaker demand from mainland Europe, the U.S. and Asia. This report provides evidence that the U.K. is suffering from the global slowdown and if a credit crunch develops in the euro area, economic activity around the world could contract more significantly, putting an even greater toll on the U.K. economy. Bank of England Governor King spent this morning trying to reassure investors that U.K. banks are better capitalized than their euro peers but he also admitted that there is only so much they can do the shield the U.K. banking sector because the problems are beyond their control. He also confirmed our own belief that yesterday’s dollar swap move will provide short term relief and not a full solution to the region’s debt troubles. According to the BoE, U.K. banks have approximately GBP160 billion in exposure to Italy, Ireland and Spain which is not an extremely small amount. Looking ahead, there are no additional U.K. economic reports this week which means the price action of the pound will be determined by risk appetite.

CAD: REBOUND EXPECTED IN LABOR MARKET

After the blockbuster moves higher on Wednesday, the Canadian, Australian and New Zealand dollars consolidated against the greenback. Weaker economic data from Australia and softer manufacturing numbers from China hampered the rally in the comm. dollars. Chinese manufacturing activity contracted for the first time since February 2009 as the global slowdown cut export demand. The index slipped to 49.0 in November from 50.4 in October. Non-manufacturing PMI numbers are due for release this evening and even though activity in the sector is expected to expand, it should do so at a slower rate. Australian retail sales were also horrid. According to our colleague Boris Schlossberg, we wrote about this extensively, “Australian Retail Sales missed their mark for the second month in a row printing at 0.2% versus 0.4% eyed in a sign that consumers Down Under are turning decidedly cautious as sentiment continues to weaken. Growing concerns over the slowdown in economic growth in Asia Pacific region as well as dwindling labor market demand have clearly dampened consumer appetite as sales declined for the third month in row. In addition to weaker than expected numbers on the consumer front, the data for Building Approvals proved to be major disappointment as well with demand tumbling by -10.7% versus forecasts of 3.5% rise.  Overall the news points to a considerable cooling in the Australian economy and suggests that the RBA is likely to reduce its benchmark by at least another 25bp to 4.25% in the near future.” Canadian employment numbers will be released on Friday and a rebound is expected after the largest one month job loss since February 2009.

JPY: DATA SHOWS MORE INTERVENTION IN NOV

In a mixed trading day, the Japanese yen weakened against the euro, Canadian and U.S. dollars while edging higher versus the Swiss Franc and Australian dollar. After a sharp boost for high-yield trades by the central bankers yesterday, risk appetite slowly waned. As the uncertainty surrounding the European crisis remains the most pressing issue for the world economy, Japan’s Prime Minister Yoshihiko Noda has ordered the preparation of a supplementary budget to ease concerns about the Japanese economy. The new budget, the fourth extra bill this year, will be at least 2 trillion yen, the Finance Minister Jun Azumi said. Since the earthquake in March, the Japanese economy has been weighed down by the disrupted export industry amid Thai floods and slowing global recovery. According to the Prime Minister Noda, the yen’s gains, Thailand’s flooding and the European debt crisis are some of the factors that have increased the uncertainty of the economic outlook. The Japanese government would try not to add to the country’s debt burden with the latest budget proposal. “We will seek to finance the new budget out of cost savings and not through new bond issuance,” Noda said. While the economy has returned to growth between July and September after three quarters of contractions, the declining global demands would likely put greater downward pressure on Japan’s export-reliant economy. Meanwhile, the most recent figures showed that the Finance Ministry and the Bank of Japan stepped into the currency market for more than a day between October 28 ^th and November 28 ^th . The government has spent 9.09 trillion yen intervening in the currency market, exceeding market’s estimate of 7.5 to 8 trillion yen. However, the central bankers and the finance officials have stopped short of making a similar commitment to that of the Swiss National Bank. With its positive trade balance, the Japanese yen is one of the more appealing safe-haven currencies. If the European debt crisis continued to rout the market, the trader could turn to the yen in the time of distress. As there are no first-tiered economic releases from Japan tomorrow, the trading in yen could hinge on the news flows out of U.S. and Europe.

USD/CAD: Currency in Play for Next 24 Hours

USD/CAD will be our currency pair in play for the next 24 hours. From Canada, we expect the employment data at 7:00AM ET/ 12:00 GMT. The U.S. will release the Non-Farm Payrolls report and unemployment rate at 8:30AM ET/ 13:30 GMT.

Despite its recent decline, USD/CAD has managed to stay within the range-trading zone which we determined using the Bollinger Bands. The nearest support sits at 1.0031, the 50% Fibonacci level. A break below that level, USD/CAD could target its 61.8% Fibonacci retracement at 0.9883. We drew our Fibonacci retracement levels from the low in July to the swing high in October. On the upside, the pair’s rally could be contained at 1.0238 (50-day SMA) and 1.0347 (10-day SMA).

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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.