Will August Payrolls Disappoint the Dollar?

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The stakes are high for tomorrow’s Non-Farm Payrolls report causing some trades to reduce long dollar positions ahead of the high profile release. Federal Reserve officials made it very clear that the decision on a rate rise in September would hinge in large part on tomorrow’s jobs report.  If non-farm payrolls exceed 200K and the unemployment rate holds steady or better yet improves, then expectations for a rate hike this month will spike, sparking a broad based dollar rally that will take USD/JPY to fresh 1 month highs.  If the numbers are strong enough, we could even see 105 USD/JPY.  However, NFP disappoints we could see a nasty correction in the dollar particularly after the strong gains that it has seen this month. The steepest decline should be against the British pound and New Zealand dollars – two currencies that have performed particularly well pre-NFP.

 

Taking a look at the leading indicators for non-farm payrolls, there’s no reason to believe that the number will be overwhelming strong.  We know that Federal Reserve officials are hopeful because they have been talking about the healthy pace of job growth but the smaller amount of layoffs, rise in jobless claims and mixed confidence readings raises red flags. The increase in ADP employment change was extremely modest and t the manufacturing sector continued to shed jobs.  Our most reliable leading indicator for non-farm payrolls is the ISM non-manufacturing report and that will not be released until next week.  Even though U.S. policymakers have been adamant about the need for a further rate rise, investors have been very skeptical.  They certainly don’t believe that the economy is healthy enough for rates to rise twice this year nor are they convinced that data is strong enough to warrant a hike in 4 weeks.  An unambiguously positive report would be needed to convince them otherwise.

Will Aug NFPs Help or Hurt USD/JPY?

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The focus now shifts to the U.S. dollar.  Non-farm payrolls are scheduled for release tomorrow and ahead of this key event there was very little consistency in the performance of the dollar.  The greenback traded lower against JPY, AUD, NZD and CAD but moved higher versus EUR, GBP and CHF.  After the strong increase in June, there’s no doubt that job growth slowed in July and the big question is by how much. Economists are currently calling for job growth around 180K and any reading greater than 200K will be positive for the dollar as long as the unemployment rate improves and average hourly earnings rise as expected.  Any miss in the headline or underlying components will send the dollar tumbling lower.

While the leading indicators for non-farm payrolls point to a decline, the number may not be that bad.  The 4 week moving average of jobless claims declined, continuing claims are lower, Challenger Grey and Christmas reported a sharp drop in job cuts and corporate payrolls increased slightly according to ADP.  Although the employment component of non-manufacturing and manufacturing ISM declined, the dip was small and consistent with the drop in payrolls already forecasted. Consumer confidence is also down marginally according to the Conference Board’s survey, leaving the only major deterioration reported by the University of Michigan.  There’s no doubt that the U.S. economy is outperforming its peers, which should make U.S. assets and the U.S. dollar more attractive in comparison.  For these reasons and the fact that Japan’s big event risks are over, we anticipate a stronger recovery in USD/JPY.

 

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BoE Preview – Rate Cut AND QE?

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Tomorrow’s Bank of England meeting is one of the most important events this month.  Back in July, U.K. policymakers made their plans to ease in August abundantly clear and now that the time has come, sterling has been surprisingly stable.  By giving investors sufficient warning, the market had the opportunity to completely discount a 25bp rate cut and the question now is if the BoE will do more. They could cut interest rates by 50bp or they could combine a quarter point cut with renewed bond buying. Quantitative Easing was a critical part of the BoE’s monetary policy during the financial crisis but with interest rates already so low, the effectiveness of QE is in question. Many economists believe they will revive the program but not this week. Since Britain decided to leave the European Union, the Bank of England has taken major steps to stabilize the financial markets and encourage lending – and so far it has worked!  Stocks are stable, yields have increased and the doomsday sentiment in the market is fading. A lot of this has to do with the U.K. government’s decision to postpone invoking Article 50 for the next year or two, reducing the immediate risk for businesses.   This means the central bank can wait to ease again when there is a greater evidence of a deep contraction in the economy.

Taking a look at the table above, there’s certainly been more deterioration than improvement in the U.K. economy since the July monetary policy meeting. However wages are up, the unemployment rate is down and consumer prices are ticking higher.  Second quarter GDP growth was also better than expected.  Although manufacturing, services and the composite PMI indices fell sharply in July, this morning’s numbers were not revised lower after the flash release.  When the Bank of England releases their Quarterly Inflation Report tomorrow, their forecasts will be grim – policymakers previously warned of a possible recession post Brexit.  Governor Mark Carney won’t have anything positive to say outside of acknowledging financial market stabilization.  Yet economic and financial conditions are not desperate enough for the Bank of England to rekindle their QE program.

In other words, we feel that the Bank of England doesn’t need to send a strong message to the market right now outside of a 25bp rate cut and a stern warning of more easing in the coming months.  If we are right, we could see a bigger short squeeze in GBP/USD that will allow investors to reset their short positions at higher levels.  The U.K. is not out of the woods, as growth will only slow further in the coming months / years because the U.K. government is simply delaying the inevitable.  If they cut by 50bp or restart their bond buying program, sterling will fall quickly and aggressively.

RBA Rate Cut – Not a Done Deal

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The Reserve Bank of Australia also has a monetary policy announcement and the majority of economists surveyed expect the RBA to cut interest rates by 25bp but we feel that a rate cut is not a done deal.  The last time we heard from the RBA they sounded open to the idea of easing if data supports it but since the last meeting in July, manufacturing activity accelerated, consumer prices increased, full time job growth rebounded, business confidence improved and the participation rate is up as shown in the table below. Granted consumer confidence is down and the unemployment rate ticked up, we’re not sure if this is enough for the RBA to pull the trigger on easing in August. The AiG Performance of Manufacturing Index rose to 56.4 vs. 51.8 previous.  Chinese PMI numbers were mixed. The official manufacturing PMI showed a decline from 50 to 49.9. The Caixin Manufacturing PMI reading registered an increase in activity, coming in at 50.6 vs. 48.9 expected. Australia’s trade balance and building approvals report will be released pre-RBA but the rate decision will be key. If the RBA cuts, AUD/USD will drop below 0.75 cents quickly but if they hold rates steady, we should see Monday’s high of 0.7615 recaptured.

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