US Dollar
It has been quite a volatile day in the currency markets. The initial reaction in the dollar after the March non-farm payrolls report was rather muted as the market tried to decide what to do with the mixed report. Even though non-farm payrolls increased by a more than expected 211k last month, the 18k downward revision in the prior figure pretty much negated the surprise. Taking a look at the further details of this morning's release, we see that the unemployment rate ticked lower from 4.8 percent to 4.7 percent, but the manufacturing sector saw more job losses. Additionally, wage gains were modest at best with average hourly earnings growth slowing from an upwardly revised 0.4 percent to 0.2 percent. Given that the market was really looking for an unambiguously good set of data, the market's first reaction was to sell dollars. However, as soon as dollar bears realized that the rally contained little follow through, profit taking ensued and the dollar began to recuperate its losses, causing the first wave of selling in the EUR/USD. The second wave came right after option expirations at 10am, which opened up the flood gates for a flush down to 1.2100. Traders were looking to the bond market for direction and saw that yields on the 30 year bond shot to 5 percent. Commodity prices also retraced, adding fuel to the rally. Most reports are crediting the dollar's rise to traders and analysts pricing in another quarter point rate hike in May, which is actually quite surprising since it has already been a widespread belief that we would have at least one or two more rate hikes over the next few months. With last week's hawkish FOMC statement, we would be surprised to find anyone that may have though 4.75 percent was the top. In fact, FOMC member Poole said in his speech today that 5.25 percent rates is "reasonable given what we know." Therefore this suggests to us that the latest move is just a flush with the only major shift in fundamentals coming from the words of the ECB, who recently signaled their plans to delay their next rate hike to June. So perhaps the move today was an adjustment of expectations on who would be the more hawkish central bank over the next two months. The week ahead still brings about a lot of uncertainty, including the US trade balance and retail sales report. The consumer spending figure will be the most important number to watch since it can easily shift expectations once again. The market is worried about housing and the clearest sign that the housing slowdown is being felt by consumers is through spending.
Euro
The Euro fell victim to dollar strength today as the market reacts to the non-farm payrolls report. One of the questions being asked is whether the Euro could fall victim to the sudden change in sentiment like it did last year after the rejection of the EU Constitution. As it stands now, we can say that the scenario is very different. The European Central Bank is simply delaying an inevitable rate hike rather than completely cutting their tightening cycle short. When voters rejected the EU Constitution, the complete structure of the European Union broke down and the market was left with an uncertain fate. There was even talk that the Euro could disappear if Italy decides to readopt the Lira. The fears have of course come and gone since then as the market realized that the collapse of the EU Constitution was not synonymous with the collapse of the Euro. The only major point of the debate is how the ECB will respond if the Euro continues to appreciate. The French Finance Minister credited the ECB with today's Euro slide while Trichet came on the wires shortly thereafter clarifying that FX rates did not impact the ECB's decision. We doubt that this is true since most central banks are sensitive to exchange rates. The ECB needs to be even more careful since the Eurozone is so export dependent. As mentioned in this morning's FX Brief, the ECB learned a solid lesson when the 2004 spike in the EUR/USD to 1.36 pushed the Eurozone economy into a near recession. They do not want to make the same mistake the second time around, especially since toning down their comments only has positive benefits for growth by boosting exports and keeping demand domestic. Data released overnight was also positive for the Euro with the trade surplus and current account surplus both expanding. In addition, the OECD's measure for leading indicators increased from 107.9 to 108. In the week ahead, the Eurozone also has a heavy economic calendar with a lot of inflation reports due for release. We expect volatility to continue to pick up in the week ahead.
British Pound
With nothing notable on the UK economic calendar, the British pound extended yesterday's moves by sliding against the dollar and rallying against the British pound. In the week ahead, the UK economic calendar contains some key releases including producer prices, the trade balance and employment data. However, with most reports coming out of the UK showing conflicting results, we doubt that it will give the British pound much direction.
Japanese Yen
The dollar broke higher against the Japanese Yen today despite more pressure on China to revalue the Yuan and the release of a report by a think tank forecasting faster moves from the Bank of Japan. Treasury Secretary Adams was on the wires saying that China is acting far too cautiously and could easily move more rapidly on the Yuan. This has been the belief that the US government has held for sometime, but revaluation is coming back into focus with the Chinese President visiting the US later this month. The Bank of Japan will be releasing their monthly report next week and it will be interesting to see how positive they are on the economy and how they view the current state of deflation. Although it is still a bit too early, it will soon be Japan's time to shine when they decide to drop their zero interest rate policy. The market is waiting for this shift and when it does happen it could be extremely positive for the Yen. Also, there is a strong rally that is happening in the Tokyo Stock market, with the Nikkei closing above 17.500 for the first time since July 2000. Foreign investors will only become more interested in Japanese investments. In fact, the yen is already rallying against the crosses.
Kathy Lien is the Chief Currency Strategist at FXCM.