Dollar: Will Non Farm Payrolls Spoil the Rally?

It was a pretty good week for dollar bulls as the unit managed to gain 130bp against the euro on surprisingly buoyant economic data including better than expected Durable Goods, New Home Sales and Chicago PMI numbers. For dollar bears betting on the collapse of the US economy this week was a sorely disappointing experience as all signals suggested that growth may have eased but not stopped altogether. However, as we noted at the start of last week, “The key determinant of dollar’s direction will continue to be the state of the US consumer. If gasoline prices remain sticky above $4/gallon, it is difficult to imagine any other scenario but a recession for US economy as we move into the 2nd half of the year.”

The single biggest factor driving consumer sentiment is employment. That why next week’s currency trade is very likely to be dominated by absolute focus on the Non-Farm payroll report due June 6th are 12:30 GMT. The market expects a fifth consecutive month of job cuts, but the true measure of dollar’s strength or weakness is likely to be determined by the amplitude of the loss. If the NFP’s contract by more than -100K jobs, talk of an oncoming recession will quickly sweep FX trading desks and markets may begin to price in yet more rounds of Fed easing.

Over the past few weeks, as worries about the credit crunch have dissipated, US rates on the 10 year bonds have started to rise, providing support for the greenback, but that scenario will quickly reverse if the job picture showed significant deterioration. The EURUSD now finds its way at the midpoint of its 1.60-1.50 recent range and may stay within at these levels for the time being unless the data from the US signals the start of a fresh downturn. The dollar rally will continue only if we see further upside surprises this week, otherwise equilibrium and choppy trade conditions are likely to persist.

Euro Tumbles as Data Disappoints

The EZ news on DailyFx was peppered with following headlines this week, “EZ Post Worst Trade Deficit in a Decade” and “Euro Kneecapped by Deteriorating Consumer Confidence” finally ending on Friday in “Euro Dips Below 1.5500 as German Retail Sales Plunge”. In short it was hardly an auspicious week to be a euro long as day after day the economic news from the region continued to disappoint suggesting that the long awaited slowdown in economic activity caused by high exchange rates and even higher inflation readings may have arrived.

As we noted on Thursday, “The economic picture in Europe remains mixed as the economy continues to expand at a moderate pace but warning signs abound that high exchange rates and high energy costs may take a serious toll on growth in the 2nd half of 2008. At the very least the current state of the EZ economy shows that there is virtually no chance for an ECB rate hike into the later half of this year and as such dampens any euro rally going forward.”

Yet despite the difficulties this week, next week may prove more productive for euro bulls. Most the regions data is expected to post positive month over month comparisons, most notably the PPI numbers which are forecast to print at 6.1% vs. 5.7% the period prior. Should price gauges continue to rise, they will keep ECB monetary bias decidedly hawkish while on the other side of the Atlantic the Fed may be faced with the unpalatable prospect of further easing if the job picture deteriorates materially.

Fundamentals Take A Heavy Toll On An Already Weakened Yen

Japan saw its economic picture grow dimmer with a slew of fundamental data disappointing last week. April’s retail trade fell 0.1% from 0.5% the month prior and household spending fell 2.7% in April-the most in 19 months. Although, headline CPI eased to 1.0% in April from 1.2% the month prior, Tokyo CPI Ex Fresh Food accelerated to 0.9% from 0.7%. Meanwhile, the jobless rate rose to a seven month high of 4% from 3.9% and industrial production fell 0.3% in April. Inflation remaining near a decade high has diminished consumer’s purchasing power. Also, as the growth continues to slow and the labor market begins to weaken, the BoJ finds itself in a difficult situation with very little room to maneuver with interest rates at 0.50%.

The BoJ is monitoring price increases in oil and food as inflationary pressures mount. The central bank may look to raise rates to head off rising prices but with growth continuing to slow it will make it difficult for the central bank to employ a tightening bias. Manufacturers have seen new order decline over the four months and are expecting demand for cars and electronics to slow through next quarter as the U.S. downturn and weak dollar has dried up demand for Japanese goods.

Risk appetite has wreaked havoc on the yen as it was sold off all week as the carry trade came into play. Equities mad a steady climb throughout the week across most of the major indices. Investors borrowed the funds at the Japan’s G-10 low interest rate of 0.50% and then sold the currency against other currency to invest in higher yielding assets. The currency movement for the week is expected to at the mercy of the risk winds as there is very little economic data on the docket. Labor cash earnings is expected to decrease which will impact future consumer consumption, but may not have a significant impact on price action.

British Pound Consolidation Could Result In A Break Higher

The British pound did little but consolidate its gains versus the US dollar last week as UK economic data proved to be mixed. While BBA mortgage approvals rose to 38,704 in April from 35,546 in March - the lowest since record keeping began in September 1997 - this level was still nearly 40 percent lower than a year earlier. It is rather clear that tighter lending standards and weakening consumer confidence are taking a toll on the UK housing sector, which will only add pressure to already-plummeting property prices. In fact, the Nationwide home price index tumbled 2.5 percent during the month of May – the sharpest decline since record keeping began in 1991 – while prices fell 4.4 percent from a year earlier. Indeed, tighter lending standards have cooled demand for properties and mortgages, leaving the UK housing sector a major soft spot for the national economy.

Looking ahead to this week, UK data is likely to continue reflecting weakness in the housing, manufacturing, and services sectors. The Bank of England is expected to leave rates steady on Thursday at 5.00 percent for the second month in a row as rocketing inflation pressures prevent the Monetary Policy Committee from focusing on tighter credit conditions and the collapse of the UK housing sector. The rate decision will come at 7:00 EDT and since the MPC is anticipated to leave rates unchanged, they are unlikely to issue a monetary policy statement which should leave the market’s reaction to the news very muted. Nevertheless, if UK economic indicators released earlier in the week prove to be very disappointing and weigh on the British pound, the currency could actually surge on the rate announcement on Thursday.

Swiss Franc Drops Amidst Pick Up In Risk Appetite

The Swiss franc tumbled over the course of the week as global equity markets made a comeback, leaving the safe-haven currency to suffer. While Swiss economic data was certainly disappointing enough to create bearish sentiment on the Swiss franc, as the currency showed itself far more sensitive to shifts in risk appetite. First, the UBS Consumption Indicator fell for a second month in April to 2.179 from 2.249, suggesting that households are cutting back on their spending plans. Meanwhile, the KOF Swiss leading economic indicator fell for the 10th consecutive month in May to 1.09 from 1.21, as slowing global growth and record oil prices weigh on the outlook for the economy. On the other hand, the Swiss labor market expanded in the first quarter by 2.8 percent to 3.899 million as export demand prompted companies to add to their workforces. Nevertheless, this is a far more backward-looking release compared to the UBS and KOF indicators, suggesting that the downside risks to growth in Switzerland remain very much to the downside.

This week, traders will get the opportunity to see just how dour the Swiss growth scenario is, as Q1 GDP figures will be released. Indeed, the economy is expected to have only grown 0.3 percent from the first quarter – the weakest pace since Q3 2004 – and 3.3 percent from a year earlier. Meanwhile, SVME PMI is anticipated to drop to 55.4 from 56.7 - indicating worsening business conditions – while CPI is forecasted to edge up to 2.4 percent amidst rocketing commodity prices. Clearly, the Swiss economy is having difficulty grappling with weakening foreign demand for exports and surging energy and food prices. However, much like the European Central Bank, the Swiss National Bank is highly unlikely to cut rates when they meet in June given substantial upside inflation risks. This may have little bearing on price action for the Swiss franc though, and it will be very important to watch developments in global risky asset classes, as the USDCHF and pairs like USDJPY continue to move in line with the US S&P 500 Index.

A Drop In GDP Produces Quick End To A Strong Canadian Dollar Run

The Canadian dollar had enjoyed a steady advance across the majors for nearly a month – that is until this past week saw the loonie finally loose steam. Technically, USDCAD was on the move over the past two weeks thanks to the pair’s break below parity - which stood as range support for half of March and all of April. However, USDCAD is notorious for brushing off major technical formations and leaving many speculative traders with a floundering position. Since the loonie pair pushed below 1.0000, price action has quickly turned to consolidation with parity standing as the new line of resistance.

This choppy price action has its roots in both scheduled and unscheduled event risk. Off the docket, the Canadian currency was finally tightening its correlation to price action in the crude market. This came at an inconvenient time however as the volatile commodity stalled its record breaking advance and pulled back below $130/barrel. More significant for the fundamental crowd though was the indicators on the economic docket. Coming late in the week, the first notable release gave the Canadian dollar a boost which seemed to promise a new multi-month high. The first quarter current account balance confirmed the economy’s main source of growth – trade. The broadest gauge on international trade marked a significant rebound in the nation’s long-standing surplus by hitting a one-and-a-half year high C$5.6 billion – nearly double the consensus. What’s more, the first negative reading in a decade from the fourth quarter was revised to a positive gap of C$0.8 billion. However, there was reason for caution as the substantial improvement of trade was based almost solely on the commodities sector. The next indicator to hit the wires undid all the good will the trade numbers provided. Over the first quarter, the Canadian economy reportedly contracted for the first time since 2003. details of the report reveals this was due to a sharp drop in business investment, a notable drop in manufacturing and a contracting housing market. This economic stumbling suggested that the economy was not immune to the US slowdown and that the BoC has the scope to continue with its recent spat of rate cuts.

For the coming week, the economic calendar is sparse; but just like last week, the few indicators populating the list are consistent market movers. The fundamental tides will swell on Thursday with the release of the April building permits and May Ivey PMI numbers. The housing numbers will be monitored closely as a consumer spending and credit health gauge after the GDP report revealed weakness. The business activity report will be more market moving however as traders monitor the weak link of the economy – manufacturers who are suffering from high input costs and a stifling exchange rate. Finally, Friday’s employment numbers will market top event risk as the market is clearly now more dependent on domestic consumption for positive growth. Outside of the well-known release times of the docket, commodity trends could also boost liquidity over the coming week. If crude marks a major retracement, the loonie could easily follow suit.

Australian Dollar Decline May Turn To Reversal On GDP, RBA Event Risk

A listing of secondary economic indicators may have helped curb the Australian dollar’s record breaking advance last week. After pushing above heavy resistance seen at 0.95 the week before last, bulls failed to generate significant follow through. In fact, AUDUSD has been consolidating between 0.9650 and 0.9500 ever since. This lack of momentum on a break to 24-year highs suggests the market may not have the necessary strength to make a run to the pivotal 1.0000 (parity) level that so many technical and fundamental traders are no doubt targeting.

When trading activity picked back up last week, most traders – even those of the fundamental persuasion – wouldn’t have expected the indicators scheduled for release to dramatically impact the health of the Aussie dollar. Recent history has shown that the Leading composite indicators, consumer lending and quarterly capital expenditures reports have roused little response from price action. However, with the Australian currency pushing multi-decade highs on the basis of a strong and sustainable pace of economic expansion and rising interest rates, there seems to be greater sensitivity to important economic data – and last week’s data certainly has considerable pull for growth forecasts. The Westpac and Conference Board Leading Index indicators – both for March – offered a forecast for expansion over the coming three to six months. The Conference Board’s reading reported its third consecutive monthly contraction, while the Westpac’s annualized gauge cooled for a fourth consecutive month. Elsewhere, business investment was clearly weighed down by the 12-year high in the benchmark interest rate and stifling credit costs. Capital expenditure for the first quarter dropped unexpectedly by 2.5 percent. Most concerning of all though was the private sector credit reading. Borrowing rose the least since July of 2001 through April, suggesting consumer spending may drop over the coming months.

If the previous week’s calendar could stall a potentially strong run, the coming period’s docket could lead to a major market turn or offer the necessary fuel to finally push AUDUSD to parity. All of the Aussie’s most market moving indicators are scheduled for release over a few days’ span. Ranking the indicators is difficult, but the RBA rate decision likely has the greatest potential as the group said they had a considerable discussion about another rate hike when they last met on May 6th. The next major landmine is the first quarter GDP number. Australia has been growing 17 straight years and has shown promise as being one of the few bulwarks in a global slowdown. If expansion cools from 3.9 to 2.8 percent as expected, one of the primary drivers behind the Aussies strength will crumble. Finally, the retail sales report will give a read on the consumer’s health at the beginning of the second quarter - but fundamentals aside, it is simply a consistent volatility driver.

New Zealand Dollar Could Rally if RBNZ Shows Steady Hand

The New Zealand dollar finished the week effectively unchanged against its US namesake, as choppy price action across world equity markets made for similarly listless movements in the high-yielding NZD. Largely positive economic data offset drops in relevant commodity prices, and New Zealand’s currency heads into the coming week’s Reserve Bank of New Zealand Official Cash Rate decision on unexpectedly solid footing. Some economists claim that recent fundamental developments have improved expectations for the future of RBNZ interest rate decisions—a clearly positive development for the yield-sensitive NZD. This past week’s RBNZ Inflation Expectations data surprised markets and likely raised some eyebrows at the central bank itself. According to RBNZ surveys, business respondents expect that Consumer Price Index inflation will hit 2.9 percent over the next two years—a noteworthy deterioration from previous expectations of a 2.7 percent rate. Such headline CPI growth would rest a mere 0.1 percentage point below the bank’s official target of 3.0 percent and the prospect presents a clear challenge to the monetary policy authority. It is subsequently safe to say that the RBNZ’s OCR will remain unchanged through the near term. Yet analysts and traders alike are significantly less confident on whether to expect interest rate cuts through the end of 2008—making the upcoming RBNZ statement critical in shaping outlook for domestic yields and, by extension, the New Zealand dollar.

The RBNZ’s scheduled interest rate announcement will dominate an otherwise quiet week of event risk for the NZD, but it will likewise be important to watch the results of interest rate decisions out of Australia and labor data for the US economy. Kiwi traders will likely react to the smallest of nuances in RBNZ Governor Alan Bollard’s highly anticipated statement, and some claim that the Governor will prove a good deal more hawkish than market yields currently imply. Bollard is stuck between a rock and a hard place, as a relatively clear deterioration in domestic consumer confidence and employment prospects suggest that spending and growth will slow noticeably through the foreseeable future. Yet it is likewise clear that the RBNZ must pay close attention to elevated inflation, and its strict inflation-targeting regime may force it to maintain rates in restrictive territory despite deteriorating economic conditions. All in all, the statement could be a significant boost for New Zealand dollar if expectations of a hawkish RBNZ come to fruition. Otherwise, the NZD will trade off of similar event risk from the Reserve Bank of Australia and the always market-moving US Non Farm Payrolls report.

Boris Schlossberg is a Senior Currency Strategist at FXCM.