US Dollar, Japanese Yen Ease Lower - US NFPs Could Determine Risk Trends on Friday

The US dollar and Japanese yen both fell against most of the majors on Thursday as risk sentiment improved, albeit very slightly. Indeed, US equities ended the day higher, as the S&P 500 gained 11 points to 842.46 and the DJIA rose by 75 points to 8750.24. While the DJIA closed above the 200 SMA, we can’t really call it a “breakout” unless the index continues to make headway on Friday. Whether this will happen may have a lot to do with the headline event risk for the US dollar: non-farm payrolls (NFPs). Based on both a Bloomberg News poll of economists and a variety of leading indicators, Friday’s release of the NFP report is likely to show job losses for the seventeenth straight month in May, but the rate of decline is anticipated to slow. At the time of writing, Bloomberg News was calling for NFPs to plunge by 520,000, but looking at the range of estimates, economists are anticipating that NFPs could fall anywhere between 450,000 and 600,000. Based on the improvements we’ve seen in leading indicators like initial jobless claims, consumer confidence, and the employment components of ISM non-manufacturing, we expect that NFPs may drop somewhere in the range of 500,000 to 540,000.

We’ve seen that risk trends are still the primary driver of price action, as the US dollar tends to fall when investor sentiment builds and usually rallies amidst market-wide risk aversion. Thus, it will be necessary to keep this correlation in mind when trading around the time of the release of NFPs. From a technical perspective, the daily chart of the US dollar index shows that the currency bounced on Wednesday from key support at the 61.8 percent fib of 71.32-89.62 at 78.29, but on Thursday, price subsequently backed off from former support at 79.80 (the May 22, 25 lows). These two levels - 78.29 and 79.80 - will essentially become “lines in the sand” on Friday. Indeed, daily RSI for the index rose from overbought levels on Thursday, but we also saw this occur last week, suggesting this is a weak bullish signal.

British Pound Pummeled Despite Neutral BOE Tone as Political Uncertainty Builds

The British pound was ultimately the weakest of the majors on Thursday, despite the fact that the Bank of England left rates at 0.50 percent once again, as expected, and comments within the central bank’s policy statement were straight-forward. Indeed, the statement simply reiterated that the Monetary Policy Committee (MPC) would its £125 billion asset purchase program, to be financed by the issuance of central bank reserves. The MPC also said that it will take another two months to complete the program, and its scale will be “kept under review.” All told, there was nothing surprising here and certainly nothing to suggest that the BOE’s policy bias has changed in any way, shape, or form. Accordingly, GBP/USD hardly moved upon the ECB’s 7:00 ET rate decision, but clear market-movement came at 8:00 ET when the pair plunged over 200 points in a matter of minutes. The drop was generally attributed to rumors that UK PM Gordon Brown was preparing to resign, and though Brown’s spokesman denied the rumor, calling it “complete nonsense,” GBP/USD wasn’t able to recover as daily RSI fell from overbought levels for the first time since March 2008.

Euro Ends Modestly Higher Amidst ECB Optimism, But Door Is Open to Further Rate Cuts

The release of the ECB’s decision to leave rates unchanged at 1 percent at 7:45 ET initially weighed on EUR/USD, as Credit Suisse overnight index swaps had actually been pricing in a 62 percent chance of a 25 basis point hike as of Wednesday. However, ECB President Jean-Claude Trichet’s subsequent press conference at 8:30 ET proved to offer some support for the euro, as EUR/USD gradually climbed higher thereafter. In his comments, Trichet called current rates “appropriate” and said that recent data suggest that the Euro-zone recession may have bottomed during the previous two quarters, and that “economic activity over the remainder of this year is expected to decline at much less negative rates,” with quarterly GDP likely to rise into positive territory by mid-2010. On the inflation front, annual CPI growth is projected to “decline further and temporarily remain negative over the coming months, before returning to positive territory by the end of 2009.”

During the Q&A session, Trichet said that rates aren’t necessarily at their lowest level, suggesting there may be room for additional rate cuts. He also went on to say that the ECB will begin their 60 billion euro covered bond purchasing program in July, and that the central bank plans to fully implement the purchases by June 2010. The ECB will buy bonds directly in the primary and secondary markets, the issues are required to be at least 500 million euros in size, and bonds can be linked to assets from either private or public entities. The “credit easing” program is relatively small compared to those implemented in the UK and US, and Trichet refused to comment on any eventual expansion of the program.

Canadian Dollar Dominates Following the BOC’s Policy Announcement - Employment Numbers Could Weigh on Friday

The Canadian dollar was easily the strongest of the majors, rallying no less than 1 percent against the Australian dollar, euro, Swiss franc, US dollar, and New Zealand dollar. The Loonie also gained close to 2 percent versus the Japanese yen and British pound after the Bank of Canada (BOC) left their overnight rate target unchanged at a record low of 0.25 percent at 9:00 ET, and reiterated their plan to hold their target rate in place through June 2010. The central bank’s policy statement was relatively optimistic and didn’t touch upon quantitative easing, which was first brought up in their April Monetary Policy Report. The Bank said that “financial conditions and commodity prices have improved significantly, and consumer and business confidence have recovered modestly,” and while “macroeconomic risks are roughly balanced,” they believe that “overall risks to its inflation projection remain tilted slightly to the downside.” All told, the Canadian dollar was able to gain against the US dollar as Canada’s fundamental outlook seems to be much better than that of its neighbor to the south.

On Friday at 7:00 ET, the Canadian net employment change is forecasted to show that job losses totaled 36,500 during May following the surprise improvement we saw in April. Furthermore, the unemployment rate is anticipated to have risen to match April 1999 high of 8.2 percent from 8.0 percent. Since the employment change tends to be a very volatile release, this should have the greater impact on the Canadian dollar, with a sharper than expected drop likely to weigh on the currency and an unexpected positive result likely to push it higher.

Terri Belkas is a Currency Strategist at FXCM.