US Dollar Rebounds, Dow Falls 360 Points: How are Traders Positioned for Payrolls?
The US dollar rebounded significantly today partly in reaction to Wednesday’s Federal Reserve interest rate decision and partly in anticipation of tomorrow’s non-farm payrolls report. Once again, bond traders got it right. Yesterday, even though bond yields increased, the stock market rallied and the US dollar sold off. The reaction in the equity and currency markets suggested that traders thought the Fed was more dovish than hawkish while the reaction in bonds suggested otherwise. Today, the equity and currency markets have finally caught up with the bond market, with the Dow down over 300 points and the US dollar up across the board. Now that should be the correct reaction, given the Fed’s slightly more hawkish leaning yesterday. The combination of strong GDP growth and the prospect for a sizeable increase in payrolls has many journalists calling yesterday’s interest rate cut the last. Economists beg to differ however, and Fed fund futures indicate that there is still a greater than 50 percent chance for a December rate cut. In the immediate future, equity and currency traders are both positioned for a strong payrolls report. With the market so divided, NFPs could decide not only who is right, but also whether the US dollar has hit a bottom. The market is currently looking for 82k jobs to have been created in the month of October. However, following the sharp increase in the ADP report and the drop in layoffs according to Challenger, the whisper number is far higher (125-130k). If job growth is anywhere near 125k, expect a sharp dollar rally, but if it is below 90k, speculation of a December rate cut will return. The arguments in favor of strong payroll growth far outweigh the arguments supporting weak growth. Not only did private sector payrolls increase materially last month and layoffs drop, but the Hudson Employment index, Monster.com Employment Index and Help Wanted Ads all jumped. We do not get the service sector ISM report until Monday, which is after payrolls, but the employment component of the manufacturing ISM report hit the highest level since April. The only reasons why payrolls could be weak is the rise in jobless claims and fall in consumer confidence. If the labor market is really recovering, confidence would not be the weakest in 2 years. There are still a lot of skeptics out there who do not believe that the US economy has seen its worst, and it all boils down to what non-farm payrolls will mean for interest rates. If there is a reason for traders to believe that the Fed will continue to lower interest rates, then the current recovery in the US dollar will turn on a dime. Nothing is certain until we see payrolls and even then we need to watch how the market reacts to it.

Is the Swiss National Bank Endorsing Carry Trades?
The liquidation of carry trades has sent the Swiss franc higher against the US dollar, Euro and British pound, but carry trade related flow may not be the only reason why the Swissie is stronger. After falling to a 21-month low, Swiss manufacturing activity rebounded last month. It is now at 60.7, well within expansionary territory. Tomorrow, consumer prices are due for release and we expect the weakness of the Swiss franc to drive CPI higher, but that may not be enough to prompt the Swiss National Bank to raise interest rates. SNB board member Thomas Jordan said today that even though they remain vigilant on franc weakness, they do not see any signs of the franc stoking inflation and rate differential still favors carry trades. Is Jordan telling the markets that it is ok to keep selling francs for carry trade purposes? Perhaps, but when it comes to central bankers, they have been trained to give as little information in as many words as possible. There was no Eurozone data released this morning, but manufacturing PMI will be due for release tomorrow. We will be using PMI as a leading indicator for German factory orders next week.

Australian, New Zealand and Canadian Dollars All Hit by Carry Trade Liquidation
The Australian, New Zealand and Canadian dollars were hit by US dollar strength, carry trade liquidation and softer commodity prices. Even though we are looking for further appreciation in the commodity currencies over the medium term, today’s move marks a turning point for many of these currencies. The sell-offs have been strong and if non-farm payrolls are as good as we expect, there could be continuation. There will be better opportunities to buy these currencies once they have stabilized. Economic data from Australia was better than expected; retail sales and manufacturing PMI both increased significantly. The trade deficit, however, widened, but that should take backseat to the other data. Canadian employment will be released tomorrow. After the sharp rise in September, employment growth is expected to slow.

British Pound Hit by Dollar Weakness, Not Softer Economic Data
Although it would be easy to say that the weakness in the British pound today was attributed to the softer manufacturing PMI and CBI Distributive Trades report, that is not the case. The pound actually rallied after the numbers even though manufacturing conditions were the slowest in a year; and distributive trade, which is a reflection of retail sales, dropped from 12 to 10 last month. Construction sector PMI is due for release tomorrow and that is expected to be weak as well, but the price action of the British pound will be determined by US non-farm payrolls and not UK economic data.

Dow Meltdown Leads to Carry Trade Liquidation
With the US stock market falling 360 points, it would be surprising if the Japanese Yen crosses did not melt down today. The correlation between these assets remains strong and we expect further weakness in the Dow to lead to further weakness for carry trades.

Kathy Lien is the Chief Currency Strategist at FXCM.