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Thursday March 9, 2006 - 20:55:27 GMT

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Forex: Dollar Traders Discount Record Trade Deficit in Hopes for Good Payrolls

DailyFX Fundamentals 03-09-06

By Kathy Lien, Chief Strategist of

• Dollar Traders Discount Record Trade Deficit in Hopes for Good Payrolls
• Bank of England Leaves Interest Rates Unchanged
• Bank of Japan Ends Quantitative Easing but Warns that Rates Will Remain Near Zero for Some Time

US Dollar

The US trade deficit hit a record high in the month of January and as we predicted, the dollar barely budged. In yesterday’s daily fundamentals, we said that traders were so transfixed with the possibility of a very strong non-farm payrolls report that a good number would have a much more significant reaction than a bad number. Both imports and exports were strong and this time around, the strength in imports was not only due to energy prices but many other sectors as well. Unfortunately the trade balance will not be something that the market really turns it focus to until next week when the Treasury International Capital flow report is due for release. The widening is of course a concern that the market has been facing for years, but the degree of the concern rises and falls based upon how much foreign investment is coming into the country. For the time being however, non-farm payrolls is our number one focus. Yesterday, the Hudson employment index surged by 5 points, while today, the more closely watched online employment index saw a similar rise. Payrolls is a very peculiar release. Over the past few years, analysts have struggled to correctly forecast the payrolls number. According to our friends at IFR Markets, “From 1992 to 1999, the market underestimated actual payroll growth 100% of the time, by an average 136k. So far in this decade, the consensus has been on the right side of the actual as many times as it has been on the left while the surprise has been trimmed to a miss of 77k.” Although the forecast is right now 210k, the whisper number is 300k. Therefore anything sub 230k will probably be seen as a disappointment. Aside from the low level of jobless claims, warm weather, increases in the employment component of the ISM survey and a decline in layoffs supports the possibility of a strong report. However the counter argument is that just because companies are not firing, doesn’t mean they are necessarily hiring. We will have to wait for tomorrow to see which side of the argument is stronger. What we do now though is that the market has really bid up dollars in anticipation, so a sub 190k number could cause a sharp and deep slide in the dollar.


Weaker German industrial production gave Euro traders another reason to exit long positions ahead of Friday’s US non-farm payrolls release. However the surprise decline does not shift the outlook for overall recovery all that much because the details of the report indicate that the decline in construction activity may just be weather related. Furthermore, there was a very sharp upward revision to industrial production for the previous month from negative 0.5 percent to positive 0.7 percent. There was nothing new in the ECB monthly bulletin released this morning. The report confirmed that the central bank as a whole viewed monetary policy as still accommodative and along with that, further rate hikes are necessary. The only interesting comment that they made was that the rapid accumulation of foreign reserves by Asian central banks could push up global inflation.

British Pound

As expected, the Bank of England left interest rates unchanged today at 4.50 percent. We had mentioned yesterday that when they make no changes to monetary policy, they also do not make any comments. The more important monetary policy related event will be the release of the minutes for the meeting, where we actually get to see if the balance of votes shifted. Given the recent mixed to better economic data, there is a growing possibility that the one dissenting member may have shifted back to neutral. However, we will have to wait until March 22 to be sure. Meanwhile both the trade balance and industrial production reports came in stronger than expected which is in line with our earlier argument that even though economic data overall has been mixed, more releases have shown strength rather than weakness.

Japanese Yen

After much anticipation, the Bank of Japan delivered little for yen bulls. Although they made a major move to end their 5 year long quantitative easing policy, they played down the move by saying that despite the policy shift, they will still be maintaining short term rates near zero. In terms of the mechanics, they are going to shift away from targeting reserves which they have been doing since March 2001 to targeting interest rates specifically. This means that going forward, any monetary policy changes that the central bank makes will be changes to the overnight lending rate. They also implemented a target band of 0-2 percent for inflation. Yet before getting too excited, the BoJ said that aside from last night’s announcement, “there will be no abrupt change as a result of today’s policy decision.” They argued that it will first take several months to reduce excess liquidity which is the primary reason why the Japanese Yen sold off after the announcement. The market was really hoping for an interest rate hike in April but the latest comments suggest that they are in no rush to raise rates anytime soon.


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