By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
This Friday’s nonfarm payrolls report is very important with a Federal Reserve rate hike expected later this month. The jobs report is crucial to shaping expectations for the Fed meeting. With the market pricing in 96.3% chance of a hike, the U.S. economy would have to report job losses for the central bank to pass on tightening this month. However the question is not if the Fed would hike but whether it would be a dovish or hawkish hike.
If the jobs report is strong with average hourly earnings rising by 0.3% or more, investors will expect the central bank to be optimistic, leaving the door open to another hike in December. In this scenario, not only would USD/JPY head back towards 112 but EUR/USD will sink below 1.16. If job growth accelerates (and we think it will) but wage growth slows and the unemployment rate fails to improve, EUR/USD could continue its rise towards 1.17. If payrolls rise by fewer than 150K jobs and wage growth slows to 0.2% or worse, the selloff in the greenback would be more significant with EUR/USD potentially squeezing above the 100-day SMA at 1.1710. Data hasn’t been great with German factory orders falling sharply but Italian yields continue to fall, which is good news for the euro.
Taking a look at the leading indicators for nonfarm payrolls, there’s certainly more arguments in favor of a stronger than weaker jobs report. Aside from the list below, one of the main reasons why job growth is expected to be stronger is because last month’s report was so weak. Job growth needs to accelerate if the Fed is to legitimately move forward with raising interest rates.
Arguments in Favor of Stronger Payrolls
1. Consumer Confidence Index Hits 17-Year High
2. Employment component of Non-Manufacturing ISM rises to 56.7 from 56.1
3. Employment component of Manufacturing ISM rises to 58.5 from 56.5
4. 4-Week Average Jobless Claims at 209.5K vs. 214.5K
5. Continuing Claims drop to 1.7M from 1.72M
Arguments in Favor of Weaker Payrolls
1. ADP Employment Change at 163k vs. 217K Previous
2. Challenger Reports 13.7% Increase in Layoffs
3. University of Michigan Consumer Sentiment Index Dropped to 7 Month Lows
USD/JPY sold off sharply on Friday despite stronger service sector activity and improved jobless claims. There are at least 4 reasons to explain the pair’s move. To start USD/JPY began the NY session under pressure after the Bank of Japan admitted that the idea of reducing the amount of days they would buy bonds is akin to tapering. Secondly, investors are nervous about China-US trade talks. Treasury yields were also under pressure throughout the day and when 111.10 broke, stops were triggered and USD/JPY extended its losses quickly. Tomorrow’s NFP report will have a significant impact on USD/JPY Good data will take the pair back above 111 while bad data could cause it to extend its losses to 110.00.
Labor market numbers are also due for release from Canada. Job growth last month was very strong and therefore a slowdown is expected for August. However full time job growth was very weak in July so that part of the report should be stronger. Its going to be a big day for the loonie with the IVEY PMI report released after the labor data. Traders should also watch U.S. – Canada trade talks. Negotiators have been working into through the night but there have not been any updates. Earlier this week President Trump said we’ll know in the next few days so that should be very soon. USD/CAD is trading above 1.32 but the trend could change quickly tomorrow if data surprises or the U.S. and Canada reach a trade deal.
Sterling extended its gains versus the dollar while EUR/USD hit 1.1659 before turning lower. There was no specific reason for the reversal in sterling but for the euro, German yields have been under pressure all day and factory orders tumbled in July. Sterling remained resilient as investors look forward to Brexit progress. The Swiss franc has been unusually strong and was the day’s best-performing currency next to the yen. Stronger-than-expected GDP contributed to Thursday's gains, but investors are actively unwinding their short franc positions from the beginning of the year