US Dollar Roiled After Weak NFP Report Cuts Rate And Growth Expectations

It was a dramatic end to the week for the US dollar and the markets in general. The NFP release lived up to its title as the top market-moving indicator with a reading that sent the greenback tumbling for a second consecutive session and the Dow plunging nearly 400 points. A casual glance at the headline number may have led traders to believe the May employment change was bullish on par as the 49,000-person contraction was modestly better than the 60,000 drop economists had expected. However, a more critical look at the indicator’s details and its historical context left the market selling dollars in mass. First of all, while the monthly decline was less than expected, it was nevertheless the fifth consecutive contraction – the worst performance from this gauge since the first half of 2003. The details were worse. The unemployment rate jumped half a percentage point to 5.5 percent for the sharpest increase to the jobless figure since 1986 and the highest overall level since October 2004. This incredible rise was partially induced by the large influx of students into the labor force for summer break. In fact, the monthly increase in the jobless rate for teenagers alone was the largest since 1948. More concerning for the outlook of the fragile US economy was the deceleration in wage inflation to a 3.46 percent clip – the weakest pace since January of 2006 and well below the rise in steady rise in living costs. Given all this data, there is little doubt the forthcoming drop in consumer spending will lead the US economy through a period of negative growth; but where does that leave rate expectations? Fed Chairman Ben Bernanke had factored a rise in unemployment into his recent outlook, so this should come as little surprise to rate watchers. On the other hand, this will no doubt raise the market’s interest in next week’s retail sales and consumer inflation reports, due Wednesday and Friday respectively.

Euro Unfazed By German Growth As ECB Rate Warnings Drive Bulls

Dollar weakness further boosted the appeal of the world’s second most liquid currency: the euro. EURUSD extended its Thursday reversal by an additional 185 points to bring resistance - seen around 1.58 - within bulls’ reach. For European fundamentals, the only scheduled indicator to cross the wires couldn’t trip up the euro’s rise. German industrial production unexpectedly fell 0.8 percent through April as raw material costs rose. What’s more, factory orders contracted for the fifth consecutive month for the worst streak since 1992. The weakness in demand highlights the dour outlook for growth. Indeed, the German Bundesbank remarked that after the surprise 12-year high in growth through the first quarter, activity in Deutschland over the second and third quarters would be “more subdued.” However, the ECB is clearly less concerned with growth and more attuned to inflation. In a speech today, ECB member Alex Weber confirmed the market’s forecast for a July rate hike when he said financial markets clearly understood the ECB’s message at yesterday’s public address.

British Pound Extends Gains – Will UK Inflation Data Continue to Support the Pair?

The British pound rocketed higher on Friday thanks to broad based US dollar losses. In fact, the strength has very little to do with UK fundamentals, as nearly every economic indicator from the country over the past week has weakened. Looking ahead to next week, RICS house prices are anticipated to reflect continued declines in home values, industrial output growth is forecasted to stall, and most workers are anticipated to claim jobless benefits. However, there’s something to be said for building price pressures in the UK economy, as it is the main reason why the BOE did not cut rates yesterday the release of the producer price index (PPI) is likely to highlight this. Indeed, input and output prices are likely to rocket higher at the factory gate, which will underpin the BOE’s concerns about upside inflation risks and could lead the British pound to start this week on a strong note.

Commodity Dollars: Canadian Dollar Treads Water As Record Oil Offset Weak Labor Data

The Australian dollar was one of the only comm dollars to benefit from Friday’s surge in commodity prices, as crude oil futures rocketed more than $10 higher to touch a record high of $139.12/bbl. However, the Canadian dollar – which tends to show a strong correlation with oil – went little changed over the course of the day as USD/CAD consolidated below 1.0200. Why didn’t the Loonie gain? It was all in the labor market data. Indeed, Canadian employers only added 8,400 jobs in the month of May, the weakest gain this year. The slowdown led by the services, which lost 20,200 jobs, suggesting that domestic demand may be waning as the growth prospects for the country continue to diminish. Are these prospects dour enough to lead the Bank of Canada to cut rates next week? Maybe. According to a Bloomberg News poll of economists, the BoC is expected to cut rates by 25bps on Tuesday to 2.75 percent, the lowest target rate since October 2005, as a probable recession in the US threatens the Canadian economy. However, there is some potential that the BoC will leave rates unchanged. The most recent reading of the consumer price index showed that both headline and core inflation pressures were building faster than expected, as headline CPI jumped to an annual rate of 1.7 percent while the BoC’s core measure rose to 1.5 percent. With inflation becoming a problem again and the Canadian credit markets stabilizing, the BoC may opt to wait before reducing interest rates again, which could reignite demand for the Canadian dollar.

Japanese Yen Surges Against Most Majors As Risk Aversion Returns

The Japanese yen gained against most of the majors on Friday, as conditions were indicative of market-wide flight-to-safety. Indeed, the DJIA and S&P 500 both fell more than 3 percent on record high oil prices and signs of weakness in the US economy. Clearly, risk trends remain the primary driver of the Japanese yen and as a result, traders should perhaps keep an closer eye on broad market conditions rather than economic data specifically.

Kathy Lien is the Chief Currency Strategist at FXCM.