By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
With fewer than 24 hours to go before the most important event risk this week -- U.S. nonfarm payrolls, the U.S. dollar is trading lower against all of the major currencies. In fact this has been an extremely challenging week for the greenback, which experienced broad-based losses. What’s particularly interesting about the move is that it comes in spite of an increase in Treasury yields this week. U.S. data hasn’t been terrible but it hasn’t been great either. And with the dollar rising as much as it has in recent weeks, investors have grown weary of holding dollars ahead of nonfarm payrolls and the FOMC rate decision. It also doesn’t help that JPMorgan (NYSE:JPM) analysts believe there’s a 1 in 3 chance of a U.S. recession. Bridgewater’s Dalios says the next big move by the Fed will be easing, Markit economics warns that “worse may be to come as inflows of new business have slowed,” or that Fed President Kaplan said that if in doubt, it's better to wait on raising rates.
At this stage, no one expects the Federal Reserve to tighten in March, which is one of the reasons why we believe nonfarm payrolls won’t help the dollar. If the labor-market report is weak, it will reinforce the market’s expectations that the dollar won’t receive a boost in yields and if it is strong, investors will still question whether it's enough for the Fed to pull the trigger -- the answer will be 'no'. However a strong nonfarm payrolls report should encourage the Fed to maintain a hawkish bias but it may be a few days before investors recognize this possibility.
Another reason why we don’t expect nonfarm payrolls to help the dollar is because the leading indicators that we track ahead of the report give us little confidence in a healthy report. While the following list includes more arguments for stronger payrolls, the employment component of non-manufacturing ISM hit a 2-year low and confidence has been cratering. Expectations are also high with economists predicting a sharp rise in payroll growth. While we are also looking for an uptick after last month’s low 151k reading, the increase could easily fall short of the 195k forecast. Trading nonfarm payrolls is always tricky because of the importance of the unemployment rate and average hourly earnings. Last month we saw how the market bought dollars despite the headline NFP miss because the jobless rate fell and earnings soared. This month, the risk is for a slowdown in earnings growth and an uptick in unemployment. The bottom line is there are far too many reasons to be long dollars ahead of NFP. But after the report, the opportunities should become clearer.
Arguments for Stronger Payrolls
- ADP Rises to 214K from 193K
- 4-Week Jobless Claims Moving Average drops to 270K from 284K
- Continuing Claims Dip Slightly
- Challenger Reports Lower Layoffs
- Employment Component of ISM Manufacturing Rises
Arguments for Weaker Payrolls
- Employment Component of ISM Services Hit 2-Year Low
- Consumer Confidence Index Drops to 92.2, Lowest since Nov 2014
- University of Michigan Expectations Index Falls
Nervous markets make for nervous traders but there’s one fact that can’t be argued, which is that oil, stocks and high-beta currencies are attempting to bottom with buyers sweeping in on every decline. We saw that in the remarkable resilience of the GBP/USD, the commodity currencies, which were up 1% on Thursday, oil, which tested $35 a barrel and the euro. While a large part of this may be attributed to the dollar’s exhaustion, market sentiment is clearly turning as well. However given the weakness in U.S., Chinese, U.K., Japanese and Eurozone data, we can’t help but eye these moves with skepticism. As every sell-off has been bought, big news will be needed to change the near-term trend.
The resilience of the British pound to weak data continues to astound us. With Thursday’s decline in the PMI services index we now have a trifecta of lower PMIs. Both the service and manufacturing sectors grew at their slowest pace in nearly 3 years while the construction sector expanded at its slowest in 10 months. This drove the PMI composite index from 56.2 down to 52.8, the lowest level since April 2013. Yet sterling continues to rise, taking out 3 big figures this past week. A lot of this has to do with positioning as sterling became deeply oversold, but concerns about Brexit also appear to be easing. There’s been no specific headlines or polls to suggest that the risk has diminished but we heard from German Finance Minister Schaeuble who said he “would cry if the UK votes to leave the EU.” Perhaps this is being interpreted by investors to mean that the Germans will do everything possible to avoid that scenario. 1.4200 is now resistance in GBP/USD. If it is broken, the next stop for the currency pair could be 1.4400.
Euro also traded higher on Thursday thanks to better-than-expected data. Eurozone retail sales rose 0.4% in January, which was much stronger than expected. Spending in December was also revised higher. This followed upward revisions to the Eurozone and German PMI services indices. This is the first pieces of good news that we have heard from the Eurozone in a while and on a day dominated by U.S. dollar weakness these reports had an unusually large impact on the euro.
Thursday's best-performing currencies were the Australian and New Zealand dollars. Good data continues to pour out of Australia with service-sector activity turning positive in February and the trade deficit narrowing significantly. Even as China’s economy continues to slow, we are seeing green shoots in Australia’s economy. Rising commodity prices including gold and iron ore also lent support to AUD, which climbed to fresh year-to-date highs. 74 cents is the main resistance level for AUD/USD and if that’s broken, the next stop should be 75 cents. The New Zealand dollar finally caught up to AUD thanks to an increase in the value of buildings and commodity prices. Still, NZD/USD needs to clear 68 cents before a stronger move higher can happen.
Friday is also important for the Canadian dollar, which rose to its strongest level versus the greenback in nearly 3 months. Canada’s trade balance and manufacturing PMI reports are scheduled for release Friday and these numbers could take the market’s focus away from oil. With that in mind, there’s been quite a bit of volatility in oil, which is trying to decide whether it wants to break above $35 a barrel. We’ve seen a dramatic recovery in the past few weeks and it has coincided with a strong decline in USD/CAD. The currency pair is within 100 pips of its 200-day SMA support at 1.3280. 1.3400 has been a level of magnetism and how oil trades near $35 will determine whether the pair remains below that level.