Top-10 ECB Takeaways, Nonfarm Payrolls Preview

By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.

The European Central Bank's monetary policy announcement proved to be a big disappointment as it failed to trigger a breakout for EUR/USD. Although the currency pair rose to a 1-week high of 1.1220 before the monetary policy announcement, it gave up all of its gains after Mario Draghi's press conference. The ECB head didn't have anything particularly negative to say about the economy or monetary policy outside of the expected warning that unwanted tightening of financial conditions (most likely in reaction to a negative Brexit vote) could trigger more stimulus. For the time being they remain comfortable with current policy and expect corporate-bond purchases -- which begin June 8 -- and TLTRO -- which begins June 22 -- to provide additional support for the economy. Their views even led to upgraded GDP and inflation forecasts for 2016. Still, euro traders were not impressed because Mario Draghi went out of his way to emphasize his willingness to increase stimulus if markets go haywire after the U.K. referendum. So between the ECB's dovish bias and its upgraded growth forecasts, the EUR/USD remained confined between its 1.1100 to 1.1250 trading range. A break of this range is now up to the U.S. nonfarm payrolls report.

Top-10 ECB Takeaways

1. Interest Rates Will Remain Low or Move Lower in the Period Ahead = Dovish Bias
2. ECB Currently in Wait-and-See Mode -- Needs to See Full Impact of Stimulus
3. BUT If Financial Conditions Tighten Significantly, it Stands Ready to Act Quickly = All Depends on BREXIT vote
4. There is More Stimulus on the way -- Corporate-Bond Purchases Begin June 8, TLTRO Begins June 22
5. ECB Expects Extra Impetus from Stimulus Yet to Hit
6. ECB Hikes 2016 GDP and Inflation Forecasts = ECB Optimistic About Inflation and Growth Outlook
7. ECB Can Adjust QE if Limits are Hit
8. Q2 Growth May be Slower than Q1, Not Seeing Significant Wage Pressures or Second-Round Inflation Effects
9. Global Economy and Brexit Main Risks for EZ
10. ECB Wants UK to Remain in EU

The focus now shifts to the U.S. dollar and nonfarm payrolls. USD/JPY extended its losses Thursday on the back of Japanese and U.S. equity-market weakness. Bank of Japan board member Sato also said the sales-tax delay won't affect monetary policy. The recent decline in USD/JPY has taken the pair near support at 108.25. Whether this level breaks or holds hinges entirely on NFPs. We need an unambiguously positive U.S. labor-market report for USD/JPY to recapture 109 and possibly even 110. That means nonfarm payrolls need to exceed 175K, the unemployment rate needs to drop back to 4.9% and average hourly earnings has to rise more than 0.2%. That's a lot to ask for especially with the Verizon (NYSE:VZ) strike expected to reduce payrolls by 35K jobs. Still, job growth last month was subpar, so a bounce in May would not be unusual. Every month we take a look at 8 economic indicators for clues about the state of the labor market and this month, there are more arguments in favor of a weak release. Although Challenger reported fewer layoffs and ADP reported an increase in corporate payrolls, the rise in the UMich survey was offset by the drop in the Consumer Confidence index. Jobless claims also increased, continuing claims rose and jobs contracted at the same pace in the manufacturing sector according to ISM. However the strongest leading indicator for NFPs -- the non-manufacturing ISM report won't be released until after the jobs number, so there's still chance for an upside surprise. The main focus will be on wage growth. Last month, the dollar soared despite lower job growth because wages grew at a faster pace. If the momentum in earnings can be continued, weaker job growth can be forgiven.

Arguments For Stronger Payrolls

1. Challenger Reports 26.5% Drop in Layoffs
2. ADP Employment Change Rises to 173K from 166K
3. Rise in University of Michigan Consumer Sentiment Index

Arguments For Weaker Payrolls

1. Jobless Claims 4 Week Average Rises to 276K from 258K
2. Continuing Claims Rise to 2.17M from 2.16M
3. Drop in Consumer Confidence Index
4. No Change In Employment Component of ISM Manufacturing
5. Verizon Strike Cuts 35,100 Jobs

The OPEC meeting ended with no deal on cutting production and oil prices dropped in reaction. There's very little desire among leading oil producers to reduce output and the headlines during the meeting from various nations were consistent. They all found the meeting positive and cooperative in the sense that they all agreed that production levels should remain the same. $50-a-barrel continues to cap gains in oil and encourage rallies for USD/CAD. We are now looking for a deeper pullback in oil prices but Canadian trade numbers are scheduled for release Friday and the risk is to the upside. Manufacturing activity accelerated last month according to the IVEY PMI report and with Western Canada Select oil prices rising 38% in April, export values should increase, leading to a smaller trade deficit.

The Australian dollar traded lower against the U.S. dollar Thursday while the New Zealand dollar moved higher. No economic reports were released from New Zealand but AUD fell victim to risk aversion and the drop in metal prices. Retail sales also rose less than expected, offsetting the improvement in the trade balance. Australia's PMI services report was due Thursday evening along with Chinese service PMIs.

Sterling ended the day higher against the U.S. dollar and euro in what could be interpreted as a delayed reaction to Wednesday's manufacturing PMI report. Construction-sector activity slowed in May. The PMI services report is scheduled for release Friday and based on the improvement in consumer confidence as well as the uptick in the manufacturing report, the odds favor a sterling-positive release.