By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
The U.S. dollar held onto this week’s gains and traded higher against many of the major currencies ahead of Friday’s Nonfarm Payrolls report. Of all the major currency pairs, EUR/USD was Thusrday’s worse performer as the extensively overbought pair falls victim to profit taking. We’ve noted that May is generally a very difficult month for the EUR/USD and while it may seem like the euro has fallen quite a bit already, there’s still room for further weakness if Friday’s U.S. jobs report excites dollar bulls. However that’s the hundred million question -- how good does the report need to be for the dollar to rise to fresh highs. In an environment of continued dollar weakness, we would say dollar bulls need to see job growth in excess of 275K, a decline in the unemployment rate and a sharp rise in average hourly earnings with no downward revisions to the past month’s report. Every piece of the puzzle should exceed expectations for the dollar to rise in a falling environment. But in a world of dollar strength, a smaller upside surprise could be enough to accelerate gains in the greenback and a decline in EUR/USD.
Every month we take a look at 8 related indicators for the labor market and here’s how they stack up this month:
Arguments For Stronger Payrolls
- Employment Component of Non-Manufacturing ISM Rises to 4-Month High
- Employment Component of Manufacturing ISM Rises to 5-Month High
- 4-Week Jobless Claims Moving Average Drops from 266K to 258K -- near lowest level in 4 decades
- Continuing Claims Drop to Lowest Level Since November 2000
- Challenger Reports Smaller Increase in Layoffs
Arguments For Weaker Payrolls
- ADP Drops to 156K from 194K
- University of Michigan Consumer Sentiment Index Drops to 7 month low
- CB Consumer Confidence Index declines
Both the manufacturing and service sectors saw stronger job growth in April and jobless claims plus Challenger reports show fewer layoffs. However the problem has long been hiring and according to ADP, companies added less workers to their payrolls last month. The contraction in confidence is also worrisome because it reflects concerns that could be related to the labor market including job situation and wages. At the end of the day, the Fed and most investors acknowledge that job growth is not the problem as it has consistently been moving in the right direction. The challenge is getting those workers to spend, which is directly related to confidence and wages. So with Friday’s report, the key focus should not be on the absolute amount of job growth but rather wage growth and the unemployment rate. If either misses expectations, EUR/USD will reverse and head back toward 1.1500. USD/JPY is also at the cusp of a major turn and Friday’s report will determine whether the currency pair makes it all the way to 108.00.
Meanwhile the U.S. is not the only country releasing labor data on Friday -- Canada has employment numbers due at the same time along with IVEY PMI shortly thereafter. Typically when labor data is released simultaneously from both countries, USD/CAD’s knee-jerk reaction is always to U.S. data. However the Canadian dollar has been a main focus this week and Friday’s reports will play a big role in solidifying CAD's bottom. If Wednesday’s record-breaking trade deficit is followed by a sharp drop in jobs and/or slowdown in manufacturing activity, USD/CAD will make a run for 1.3000. However if the data surprises to the upside and oil prices hold their gains, then USD/CAD could drop below 1.2800. Oil staged a strong recovery Thursday amid damaging wildfires in Alberta, Canada, home of the world’s third-largest oil reserves. The fires will be put out before we know it and oil will resume its slide.
Sterling extended its losses versus the U.S. dollar but the decline was modest given the drop in the PMI services. We have now seen a trifecta of slower growth in the U.K. economy with the manufacturing, construction and services sectors reporting slower growth in April. Some market watchers say that the weakness in Thursday’s report was priced, in but it doesn’t diminish the fact that the U.K. economy is expanding at its slowest pace in at least 3 years ahead of the E.U. referendum. Even if the 'stay' vote gains traction, we see a stronger pullback in GBP/USD.
After deep slides earlier in the week, the Australian and New Zealand dollars ended the day unchanged versus the greenback. 0.7450 is an important support level in AUD/USD, which has held so far thanks to Wednesday night’s better-than-expected economic reports. Retail sales rose 0.4% in March, which was more than the market’s 0.3% forecast. In contrast to Canada, rising exports narrowed Australia’s trade deficit. Home sales also rose strongly, offsetting weaker Chinese data. According to Caixin, China’s service sector expanded at a slower pace in April. The pullback in commodity prices and slower growth in China should keep the commodity currencies under pressure. If 0.7450 breaks in AUD/USD (it’s the 38.2% fib of this year’s rally), AUD's next stop will be 0.7330.