By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
The U.S. economy may have added 287k jobs in June, but we’re not impressed. Judging from the performance of the dollar post payrolls, most forex traders share our views. When the report was first released, USD/JPY jumped to a high of 101.28, but it reversed quickly hitting a low of 99.99. However the pullback to 100 was short-lived with the currency pair bouncing back to its pre-NFP level within minutes. Part of this is due to the rise in U.S. stocks and general improvement in risk appetite. But 100 is also a very important technical level and it is clear that there were a lot of bids at that rate. Although job growth rebounded strongly, the unemployment rate rose more than expected and average hourly earnings growth slowed. Job growth was incredibly weak in May but instead of an upward revision, the report was revised down by another 27k. And that leaves the 2-month average at less than 150k. Jon Hilsenrath of the Wall Street Journal argues that this may be enough for the Fed to raise interest rates in September -- a view we completely disagree with.
While it's true that Fed Fund futures went from pricing in an 11% chance of tightening in 2016 to 22% post payrolls, there’s no reasonable case for a rate hike before the end of the year, especially since we don’t expect any of next week’s economic reports to provide upside momentum for the dollar. The most important piece of U.S. data scheduled for release next week will be U.S. retail sales, and between the decline in wage growth, the sharp drop in gas prices in June and lower spending reported by the Johnson Redbook survey, all signs point to lower consumer spending and a more restrained increase in consumer prices. Six Federal Reserve Presidents are scheduled to speak but only two (George and Bullard) are FOMC voters. Both have hawkish leanings but given the deterioration in U.S. data and Brexit uncertainty, they could indicate that more caution is needed on raising rates. With two monetary policy announcements, continued Brexit risks, U.S. retail sales, Chinese trade and GDP numbers on the calendar, we anticipate another volatile week for the greenback. There may not be a tremendous amount of consistency as the dollar should remain weak versus the yen but strong against the European currencies and mixed versus the comm dollars.
Canada could not have reported a more different employment report: 700 jobs were lost in June and yet the unemployment rate dropped to its lowest level in nearly a year. The improvement in the jobless rate was largely driven by a lower participation rate as full-time workers dropped 40K and part-time hires increased by 39K. This marked the worst quarter for Canada’s job market in 2 years. USD/CAD hit a 1-week high on the news that, along with the wider trade deficit, drop in building permits and slower CPI growth will give the Bank of Canada strong reasons to talk about easing monetary policy at their meeting next week. For the first time in 4 months, USD/CAD ended the day above its 100-day SMA and the next stop should be 1.3200.
The New Zealand dollar continued to be the best performer but the Australian dollar did not trail far behind. No economic reports were released from either country and gold prices moved lower. But the hunt for yield continued to drive NZD and AUD higher. AUD has more risk than NZD because of political uncertainty and the recent downgrade by S&P but it has also attracted demand. Chinese data poses a risk for both currencies in the coming week but AUD should be supported by its employment report because according to the PMIs, manufacturing, service and construction sectors all saw improvements last month. There’s not much on New Zealand’s calendar outside of a speech from RBNZ Assistant Governor McDermott mid week.
Although sterling hit a 31-year low this past week, the spike-low on Wednesday followed by the consolidation Thursday and Friday suggests that there could be a near-term bottom in GBP/USD. While technically that may be true, fundamentally, there’s significant downside risk for GBP next week. The Bank of England has a monetary policy announcement and we know how Governor Carney feels about the consequences of Brexit. In the 2 weeks since Britain voted to leave the European Union, he’s spoken at least 3 times and hasn’t been shy about sharing his concerns. He’s long felt that Brexit poses a significant risk to the economy and they haven’t missed a beat in providing support to the economy. This week after 3 major property funds halted redemptions, the BoE cut capital requirements for banks, freeing up 150 billion pounds to encourage lending. Carney previously said BoE's forecasts will be updated in August to account for Brexit, which is when we expect the next major round of easing to occur. However he won’t miss the chance to prepare the market for additional stimulus when they meet next week -- so even though GBP/USD appears to be forming a base, this is far from a bottom.
Meanwhile euro could finally be buckling under the weight of the region’s troubles. The currency traded as low as 1.002 versus the U.S. dollar on NFPs, then reversed to hit a high of 1.1120 before settling back well below 1.1100. The 1.10 to 1.12 range for EUR/USD is well established but eventually we expect 1.10 to give. Not only was the latest round of Eurozone data weaker than expected with Germany reporting a smaller trade surplus and France reporting a drop in industrial production, but the region's problems continue to grow. We have talked at length about Italy’s banking sectors troubles, which along with Brexit prompted the IMF to lower its forecasts for Eurozone GDP growth. It now expects the economy to grow by 1.4% in 2016 instead of 1.6% with even slower growth if risk aversion intensifies. There are no major Eurozone economic reports scheduled for release in the coming week leaving the focus on the Eurozone area Finance Ministers meeting in Brussels, Italian bank stocks and risk appetite.