By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
The U.S. dollar continued to rise against the Japanese yen following Wednesday’s hawkish FOMC statement but the greenback failed to extend those gains to other currencies such as the euro and New Zealand dollar. This is a sign that investors are worried that the labor data will not be strong enough to reverse the greenback’s overall downtrend. There’s no question that more jobs were created in January because December’s 148K change in Nonfarm Payrolls was surprisingly small. A bounce is also likely this month as most of the leading indicators for NFPs that we typically follow showed minor deterioration. Economists are looking for 180K jobs to have been created and that’s the minimum we anticipate because job growth could easily close in or exceed 200K. However that’s not what everyone will be watching on Friday. Instead, the focus will be on wage growth and the unemployment rate, which is expected to remain unchanged while wages could slow after rising 2 months in a row. In an environment of dollar weakness where investors are looking for any excuse to drive the currency lower, softer wage growth combined with an uptick in the unemployment rate would be disastrous for the greenback regardless of the level of job growth. While NFPs could beat, we don’t think the overall report will live up to expectations. Even if the unemployment rate holds steady and wages grow by 0.2% or less, investors will be inclined to sell the dollar, driving USD/JPY back below 109.00. However if job growth exceeds 175K AND wages rise by 0.3% or more, the dollar will soar with USD/JPY making a run for 110.00
Here’s how the arguments for Nonfarm Payroll stack up:
Arguments For Stronger Nonfarm Payrolls
- 4-Week Average Jobless Claims Drops to 234K from 241K
- Consumer Confidence Board Index Rises
Arguments For Weaker Nonfarm Payrolls
- ADP Employment Index Drops Slightly
- Challenger Job Cuts Down Slightly
- University of Michigan Sentiment Index Falls Slightly
- Continuing Claims 1.953M vs. 1.905M
- Sharp drop in employment component of ISM manufacturing
One of Thursday's best-performing currency pairs was EUR/USD, which came within 2 pips of 1.25. There was no revision to the Eurozone PMI manufacturing index but there’s growing evidence of hawkishness within the ECB. There were reports on Thursday that some ECB officials want to give investors clearer guidance on how long interest rates will remain unchanged beyond their official view of “well past” the end of asset purchases. ECB member Nowotny also called for the central bank to consider ending its bond-buying program and said by September, ECB will decide what to do with its asset-purchase program. All of these headlines confirm that the ECB is comfortable with EUR/USD at 1.25. Although EUR/USD is up nearly 16% in the past 12 months, it is still well off its 5-year high of 1.40. While we continue to believe that the stronger currency will come back to haunt the EZ economy, until data turns sour or the central bank expresses significant concerns, the uptrend will remain intact. Of course, 1.25 is a natural resistance level so we could see profit taking if Friday’s NFP report is strong. Still, there should be significant buyers between 1.2250 and 1.2350. The Swiss franc is also powering higher, rising to its strongest level versus the U.S. dollar since May 2015 thanks in part to stronger data. Every one of Thursday morning’s releases from consumer confidence to retail sales and the PMI manufacturing report surprised to the upside. The greatest risk for CHF is Swiss National Bank intervention, so anyone overly long the currency should beware of an unexpected squeeze.
Sterling also extended its gains despite weaker data. According to Markit Economics, manufacturing activity slowed in January with the PMI index dipping to 55.3 from 56.2. This is the second monthly decline after hitting a record high in November. Overall the index remains very strong and manufacturing is not the largest sector in the U.K. economy. Nationwide house prices also rose 0.6%, which was much stronger than expected and helped to drive the year-over-year rate to 3.2% from 2.6%. Friday’s construction-sector PMI report should not have a significant impact on the currency. Instead, the market’s appetite for U.S. dollars and reaction to NFP should determine how sterling trades.
The Australian dollar was hit hard by profit taking on Thursday. The latest economic reports weren’t terrible – manufacturing activity accelerated according to PMI, job ads increased and import/export prices rose but building approvals fell 20% and commodity prices slipped adding to worries that the Reserve Bank, which meets next week, won’t be happy with the recent performance of the economy and most importantly, the rise in the currency. Consumer prices grew at a slower pace at the end of last year and will remain under pressure if the Australian dollar continues to rise. Although NFPs could determine how the currency trades in the next 24 hours, we believe that AUD will come under additional selling pressure with another move below 80 cents. For the first time in more than 4 months, USD/CAD ended the day below 1.23. Fresh gains in oil along with a stronger-than-expected increase in manufacturing activity was the excuse that investors needed to drive the Canadian dollar higher. At this stage, it looks like USD/CAD wants to drop to 1.22 and possibly even as far as the September 2017 low of 1.2060. The New Zealand dollar, on the other hand, continues to power higher with the relentless uptrend supported by risk appetite and a falling dollar. Job ads increased in January according to ANZ and consumer confidence and building permits were due Thursday evening. If NZD/USD closes where it is now, this would mark the 8th consecutive week of strength for NZD. The pair is due for a retracement but clearly, there needs to be a catalyst and perhaps next week’s Reserve Bank of New Zealand rate decision could provide that.