By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
In less than 24 hours, the June nonfarm payrolls report will be released. Most economists and investors expect a strong recovery in job growth after last month’s hauntingly weak print. With such a view, we would normally expect the dollar to be trading higher against the yen. But instead of rising, USD/JPY fell for the fifth trading day in a row. The latest U.S. economic reports were actually better than expected with ADP beating expectations and jobless claims rising less than anticipated. Treasury yields also rebounded, which should have sparked a rally in USD/JPY. But the theme of the day was 'risk aversion' and the currency pair fell victim to liquidation of all low-yielding currencies. Everyone is now left wondering whether Friday’s nonfarm payrolls will be strong enough to take USD/JPY back to 102.
To answer that question we start by taking a look at how the leading indicators for nonfarm payrolls stack up:
Arguments In Favor Of Stronger Payrolls
- End of Verizon (NYSE:VZ) Strike adds 35K jobs
- ADP Reports 172K Rise in Payrolls vs. 168K Previous Months
- Sharp Rise in Employment Component of ISM Non-Manufacturing
- Jobless Claims at Lowest Level Since April
- Continuing Claims Drop
- Employment Component of ISM Manufacturing Returns to Expansion
- Consumer Confidence Index Hits 8-month Highs
Arguments in Favor of Weaker Payrolls
- Challenger Reports Smaller Decline in Layoffs
- University of Michigan Consumer Sentiment Index Declines
As you can see, the arguments for a rebound in job growth far exceed the arguments for deterioration. Of course, if payrolls grew by less than 38K in June, the U.S. economy and the U.S. dollar would be in big trouble and the 180K forecast fully accounts for the improvements suggested by the above reports. So for USD/JPY to have a positive response to NFP, we would need to see payrolls rise by 200K or more AND see average hourly earnings growth hold steady or exceed 0.2%. Given the magnitude of last month’s disappointment, that’s a lot to ask. However in order for any recovery to be sustained, we need to see payrolls rise by 250K or more. Otherwise the reversal post data will be quick and aggressive.
Looking beyond nonfarm payrolls, we expect USD/JPY to find a bottom above 100. The strong yen is a big problem for Japan, especially in light of Chinese devaluation. The Bank of Japan meets at the end of the month and is under significant pressure to ease. Unlike U.S. stocks, which are still trading near their highs, the Nikkei is down 20% year to date. Knowing that easing alone will have a limited effect on the economy, we would not be surprised by a combination of monetary and fiscal stimulus. Desperate times call for desperate measures and that is exactly what Japan needs at this time.
Meanwhile, the market remains laser focused on the British pound, which traded as high as 1.3047 before dropping below 1.2900. Better-than-expected U.K. economic data helped to send the currency higher but as the U.K. political landscape continued to dissolve, sterling gave up all of its gains. It did not matter that house prices increased sharply in June or that industrial production dropped -0.5% instead of -1% because none of these reports reflect the state of the economy post-Brexit. It will be another month or two and possibly even three before we see how much damage was done to the economy. In the meantime, there is no support until the June 1985 low of 1.2565. U.K. trade numbers are scheduled for release Friday but we are far more interested in the Gfk’s post referendum consumer confidence report.
The euro spent most of Thursday below 1.1100 as evidence of trouble in Italy’s banking sector grows. On Wednesday we pointed out that Italian bank stocks have fallen 30% in the last 2 weeks and according to a recent report from the WSJ, 17% of bank loans in Italy are bad debt, which is 3 times more than what the U.S. had during the financial crisis. It’s a ticking time bomb ready to go off. In order to avoid this scenario or shore up the economy when it happens, the Italian government will either have to inject money into the financial system or the ECB will need to ease monetary conditions. German industrial production was also significantly weaker than expected, adding pressure on the currency.
Aside from the U.S., Canada will also release its employment report on Friday. Economists are looking for softer numbers but the sharp rise in the employment component of Thursday’s IVEY PMI report suggests that the risk is to the upside. Manufacturing activity returned to expansion in June but investors ignored the report, choosing instead to take their cue from oil, which dropped close to 5% on the back of a smaller decline in inventories. Technically, USD/CAD appears poised for further gains but the path of the currency will be dictated exclusively by Friday’s U.S. and Canadian employment reports.
The New Zealand dollar was Thursday’s best-performing currency thanks to comments from RBNZ official Grant Spencer, who warned that further cuts in New Zealand’s OCR would lead to financial instability. This signaled a lower chance of rate cuts come August. In efforts to cool the heated housing market, officials are considering an increase in Loan to Value Ratios to curb investor demand and bolster bank balance sheets in case of a downturn in the housing market. In contrast, the Australian dollar was hit hard by S&P’s decision to downgrade the country’s sovereign debt rating. The greatest losses were seen against NZD whereas AUD/USD held up well thanks to yield and carry.