By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
Thursday's best-performing currency was the British pound, which gained more than 1% versus the euro, U.S. dollar and many other major currencies. Before the North American open, the British High Court ruled that the government’s plan for Brexit needs Parliamentary approval. Investors cheered their decision by taking sterling sharply higher as they know it will now take longer for the government to invoke Article 50. More importantly, this means the eventual terms of exit should be milder as most members of Parliament did not support the decision to leave the European Union which means we are looking at a soft and not hard Brexit. Acting fast, Prime Minister May has already appealed the ruling and the Supreme Court will hear the case on December 7th. We doubt that they will overrule the High Court’s decision because getting the entire government involved in this process is extremely important due to the potential magnitude of the consequences for the U.K. economy and how the country operates as a whole. Considering that a large part of sterling’s weakness was driven by Brexit fears, a strong short squeeze is more than justified. This is especially true given the less hawkish comments from Bank of England Governor Carney. The central bank is no longer looking to lower interest rates this year and in Carney’s words the “BoE has neutral bias on policy going forward.” This is largely due to the improvements in the economy and rising price pressures. While 1.25 is significant barrier of resistance, given the positive fundamental factors we believe this level will be challenged again in the very near future.
Sterling's rally was also fueled by broad-based U.S. dollar weakness. The October nonfarm payrolls report is scheduled for release Friday and there’s little reason to believe that job growth was strong. Taking a look at the leading NFP indicators, the service sector reported slower job growth, jobless claims rose to a 3-month high, driving the 4-week average up to 257K. ADP reported a smaller increase in corporate payroll growth and confidence is down all around. Yet the Federal Reserve keeps saying that the labor market is improving and job gains have been solid, so clearly their bar is low. The main arguments for stronger job growth in October center on disappointing numbers in September. Unfortunately the arguments in favor of weaker payrolls are not very convincing since manufacturing jobs are broken out of the nonfarm report. Also, fewer layoffs and continuing claims for jobless benefits does not automatically equate to more hiring. That said, last month’s leading indicators predicted stronger job growth, so a rebound is possible. However in order for nonfarm payrolls to help the dollar, we need job growth to exceed 200K, the unemployment rate to drop to 4.9% and average hourly earnings to rise by 0.3% or more. That’s a lot to ask and if any part falls short, the dollar could resume its slide ahead of next week’s U.S. presidential election.
Arguments Favoring Weaker Payrolls
- Employment Component of ISM Non-Manufacturing Index Declined
- 4-Week Average Jobless Claims Rose to 257K from 252K
- ADP Drops to 147K from 202K
- University of Michigan Consumer Sentiment Index Drops to 1 Year Low
- Consumer Confidence Index Hits 5-Month Lows
Arguments Favoring Stronger Payrolls
- Challenger Reports Larger Drop in Layoffs
- Continuing Claims Drop to its Lowest Level Since June 2000
- ISM Manufacturing Index Reports Rise in Factory Employment
As for the euro, it ended the day unchanged against the U.S. dollar. After racing from 1.09 to 1.11, EUR/USD is finding difficulty breaking above this key level as gains are capped by the 50- and 100-day SMA. The 200-day SMA is not far above those levels at 1.1175. The only report out of the Eurozone on Thursday was ECB’s Economic Bulletin. The bulletin mostly confirmed previous ECB statements that the Eurozone was growing, albeit at a moderate pace with downside risks still present. ECB Weidmann also spoke Thursday, urging patience with the current economic policy for the Eurozone, saying that being ultra-loose in terms of monetary policy would increase stability risks. Early in the day, the Euro managed to touch the 100-day SMA twice, at 1.1125 but was not able to find upward traction beyond that. Upward price action however was able to keep the Euro above 1.11. The euro was primarily affected by EUR/GBP flows and while revisions to EZ PMIs are scheduled for release Friday, euro will primarily trade in reaction to the NFP and Election uncertainty.
The Canadian, Australian and New Zealand dollars all booked in gains against the greenback. The Aussie was in focus Wednesday night with data coming from China and Australia. Caixin PMI Service reported better-than-expected data with a reading of 52.4 vs. 52 the prior period. Caixin PMI Composite index also beat expectations, posting a 52.9 number, beating the prior period’s 51.4 reading. AiG Services PMI posted a 50.5 reading for October, an increase from 48.9 in September. Australia’s trade balance also managed to give a boost to the currency by closing the gap with a deficit of $1227m when a $1700m deficit was expected. The Kiwi and Loonie were both beneficiaries of the market's over-arching anti-US dollar sentiment. Loonie was the smallest gainer of the commodity currencies, being capped by oil, which continued to drop 2% to below $45 per barrel as investors were reeling from Wednesday’s surge in US crude inventories. NZD continued to benefit from Wednesday’s stellar jobs report and finished the day above 0.73. Australia was in the limelight Thursday night as the RBA was slated to release its monetary policy statement and retail sales. Canada reports its employment data and IVEY PMI on Friday.