US Dollar Holds Strong Despite Jump in Unemployment Rate to 5-Year High of 6.1%

The US dollar ended the day little changed from Thursday’s close despite a choppy morning of trading, though the currency does still remain relatively strong across the majors. The big news of the day was US non-farm payrolls (NFPs), which fell more than expected in August by 84,000, marking the eighth consecutive month of contraction in US job growth. Perhaps even worse than that, the unemployment rate surprisingly rocketed to a nearly 5-year high of 6.1 percent from 5.7 percent. On the other hand, average hourly earnings actually picked up 0.4 percent during the month of August, pushing the annual rate up to 3.6 percent from 3.4 percent. The data provides a very skewed picture to the Federal Reserve, as employment growth slows but wages pick up. This will stir fears amongst the FOMC members that surging food and energy prices over the summer has led the public's inflation expectations to rise and thus, has led them to demand higher wages. It is this "wage price spiral" that any central banker fears most, and as a result, the Federal Reserve is likely to continue sounding hawkish in the commentary. Nevertheless, fed fund futures have shifted in favor of neutral policy, as they now price in only a 2 percent chance of a 25bp hike on September 16 compared to a 28 percent chance a month ago. Event risk for the US dollar will be light over the course of the next week, though Friday’s US Advance Retail Sales could be market-moving, especially if the figures prove to be disappointing.

Japanese Yen the Only Currency Stronger Than the US Dollar – Fannie/Freddie News to Determine Outlook

The Japanese yen has gained nearly 4.5 percent against Aussie and Kiwi this past week, while the low-yielder has jumped 2.76 percent against the euro and 2.33 percent against the British pound. Why? Risk aversion. In fact, political turmoil has recently emerged, which is usually pure poison for currencies, as Japanese PM Yakuo Fukuda abruptly resigned earlier this week. Furthermore, Japanese economic data has been absolutely abysmal, but yet the low-yielding currency has remained strong against its foreign counterparts. However, with traders fleeing from risk and carry trades, the odds remain in favor of additional Japanese yen gains. A factor that will be crucial to this risk averse sentiment is the status of Fannie Mae and Freddie Mac, as the Treasury Department may announce plans to inject capital into the mortgage giants over the weekend. If this is indeed the case, the news could trigger a bout of flight-to-safety, sending Treasuries higher, stocks lower, and the Japanese yen crosses down.

British Pound Down Nearly 2% This Week – Recovery Next Week?

The British pound has fallen nearly 2 percent this week as Credit Suisse overnight index swaps have gone from pricing in 75bps worth of cuts last Friday to almost 100bps (96.8 to be exact) at this week’s close. Indeed, news out of the UK has done little to change the gloomy outlook for the UK. The Bank of England’s rate decision was essentially a non-event, as the left rates at 5.00 percent and did not issue a monetary policy statement (since there was no change in rates). Looking ahead to next week, economic releases will be a the light side, though UK producer prices are anticipated to reflect weakening cost growth thanks to the August drop in commodities. Meanwhile, UK industrial production is forecasted to fall or stagnate for the fifth consecutive month. My fundamental bias for the British pound next week: bearish. However, the currency remains extremely oversold and if the US dollar finally retraces some of its recent gains, Cable could actually gain despite bearish economic news.

Euro Consolidates Above 1.42 As Traders Still Expect ECB Rate Cuts

Despite a post-NFP surge toward 1.4350 this morning, EUR/USD continues to consolidate above 1.42. There were no top tier economic indicators on hand, and unfortunately for event risk traders, most releases next week will be of the second and third tier varieties. What does this mean for the euro? Currently, Credit Suisse overnight index swaps are pricing in 50bps worth of rate cuts during the next 12 months, compared to 35bps on Thursday. Indeed, ECB President Trichet’s commentary during his monthly price conference did little to convince the markets that the central bank will consider rising rates in order to fight inflation. In fact, since he continued to focus on the downside risks to growth, traders still believe that rate cuts will be on the way, though it may not happen anytime soon. Regardless, with interest rate expectations working out of favor for the euro, the currency could face additional losses, though it seems more likely that next week will be a time of consolidation across the forex markets.

Canadian Dollar Gains On Employment Data, Australian Dollar and New Zealand Dollar Falter

The Australian dollar and New Zealand dollar both slumped across the majors on Friday, in line with the broad declines in commodity prices. The Canadian dollar, on the other hand, gained versus most of its counterparts as Canadian labor market conditions improved more than expected in August, as the net employment change rose by 15,200 to leave the unemployment rate at 6.1 percent. However, this optimistic data was followed by the release of the Ivey Purchasing Managers Index (PMI), which dropped more than expected to 51.5 from 65.5, the sharpest decline since the contraction between November and December of 2005. Looking at the breakdown of the report, the indicator wasn't as disappointing as the headline number suggests as employment rebounded from its first contraction (sub-50 reading) since December of 2002 while prices slipped to its lowest level since March, reflecting the easing of key input costs like crude and heating oil. Next week, event risk will pick up significantly for the comm bloc. The biggest by far will be the Reserve Bank of New Zealand’s rate decision, since they are expected to cut rates for the second consecutive month by 25bps to 7.75 percent, according to 13 of the 14 economists polled by Bloomberg News. It is telling, though, that the last economist actually anticipates a 50bps cut. The key to the New Zealand dollar’s reaction, though, will be RBNZ Governor Bollard’s post-meeting commentary. Credit Suisse overnight index swaps are already pricing in nearly 150bps worth of rate cuts within the next 12 months, but if Mr. Bollard mimics his dovish policy statement from July, this sentiment will be exacerbated and the New Zealand dollar will likely plunge. Meanwhile, New Zealand retail sales, Australian retail sales, and the Australian net employment change are all likely to be negative fundamental factors for Kiwi and Aussie.

Terri Belkas is a Currency Strategist at FXCM.