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Will Non-Farm Payrolls Save or Kill the Dollar?

The big story today in the financial markets was the sell-off in the U.S. dollar.  The greenback fell quickly and aggressively against all of the major currencies right around the European close and held onto its losses to end the day down 2% against the Japanese Yen and more than 1% against the euro, British pound and Swiss Franc. There were a few different factors behind the sell-off in the greenback. The dollar initially traded lower on the optimistic comments from ECB President Draghi but those losses were contained to the EUR/USD. USD/JPY did not see any losses until 90 minutes before the European close at 12pm NY Time and only when it started to break down did the dollar collapse against all of the major currencies.

We believe that the sell-off was triggered by concerns for Friday’s non-farm payrolls report.  European traders cut their positions before the close and U.S. traders joined the selling as stops were triggered in USD/JPY.  By 1pm NY Time, the moves settled and the major currency pairs remained confined in tight ranges into the U.S. close. Investors are growing weary of the outlook for the U.S. and global economy and skeptical of the possibility of Fed tapering this year.  While we still believe that the U.S. central bank plans to reduce asset purchases in September, their decision hinges in large part on tomorrow’s release.

Economists are looking for 165K jobs to be created, the same pace of growth as the previous month.  The leading indicators for non-farm payrolls are mixed which is why the chance of a miss is just as high as a surprise though we lean towards a weaker outcome that could extend the losses for the U.S. dollar.  Jobless claims in general have been low and confidence strong.  This morning, Challenger Grey & Christmas also reported a 41.2% decline in job cuts.  However U.S. companies added fewer workers to their payrolls according to ADP and most importantly, job growth stagnated last month according to the ISM services report.  The employment component of ISM is one of our favorite leading indicators for payrolls and the big decline suggests that payrolls could be in the tens of thousands instead of in excess of 150K.

The sell-off in the dollar today suggests that some traders may have already priced in a weaker release but we think there is still room for a downside surprise and further dollar weakness.  However if payrolls surprise to the upside and print at 175K or better, all of the liquidation of dollar long positions that we saw today, particularly in USD/JPY could be reversed quickly and aggressively, with the pair potentially trading back to 98 in a blink of an eye.

Euro Bursts Higher as ECB Talks Recovery

The euro soared to a 2 month high on the back of dollar weakness and talk of recovery by the ECB.  While the European Central Bank left interest rates unchanged at 0.50%, slightly more optimism from Mario Draghi was enough to trigger a strong rally in the euro. Draghi spent a bit more time this month talking about the improvements in economic data and their expectations for stabilization and a gradual recovery in 2013.  However he did not rule out the possibility of negative rates and instead made it clear that this option was discussed along with ABS, LTROs, collateral and credit claims.  The main takeaway from the ECB today is that all options are still open but their expectations for stabilization reduces the chance for additional stimulus.  We have long felt that even though policymakers introduced the idea of negative deposit rates, the bar is high and with ECB officials divided on its efficacy, the Eurozone economy needed to deteriorate significantly for the central bank to resort to this option.  Draghi basically ruled out buying asset backed securities by saying that it would take a prolonged time to get a plan function and more importantly, the market has been dead for many years.  The central bank also did not address other types of forward guidance and together, these confirm that there is very little urgency right inside the central bank to follow last month’s rate cut with additional easing.  Part of the reason is because even though the ECB cut their growth and inflation forecasts this year, they raised their GDP forecast for 2014, reflecting their expectations for stronger growth next year.  They now expect the economy to contract by -0.6% in 2013 versus a prior mid range forecast of -0.4%.  GDP growth for 2014 is now expected to reach 1.1%, up from a prior forecast of 1.0%. The risks to their outlook remains to the downside because of structural reforms but exports along with accommodative monetary policy are expected to be the driver of recovery.  Inflation risks are broadly balanced but CPI is now expected at 1.4% this year versus 1.6% because of the volatility in oil prices. So while the ECB is keeping monetary policy easy and all of their options open, their brighter outlook means they aren’t poised to pull the trigger on additional stimulus anytime soon which was enough for FX traders to buy euros.

Big Moves in the Japanese Yen will Worry the BoJ

Saying that it has been a volatile day for the Japanese Yen is an understatement.  USD/JPY dropped almost 3% today before settling down approximately 2%. In the midst of this sell-off, USD/JPY took out the 98, 97 and 96 levels. While dollar weakness was the primary driver of the move, there’s no question that the liquidation triggered stops in USD/JPY that accelerated the breakdown.  We wouldn’t be surprised if some large funds got shaken out on this move as well considering that the Japanese Yen is more than 5% off its lows. When Bank of Japan officials wake up tonight, they won’t be happy with the moves that they have seen in the Yen and the Nikkei. Japanese stocks have fallen close to 17% in the past few weeks and the Yen is up approximately 6%, both of which is bad news for Japan.  If stocks don’t recover and the Yen refuses to resume its slide before the BoJ meets next week, the central bank could be forced to take action to calm investors and to reverse these moves.  In the meantime, the decline in U.S. bond yields, persistent drop in the Nikkei and the all out lack of Japanese demand for foreign bonds is keeping USD/JPY under pressure.  Last week, Japanese investors sold another 1.17 trillion yen worth of foreign bonds, the largest amount since April 2012.  Without the Japanese shifting their funds abroad, the impact of BoJ policies will be limited.

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