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Friday January 5, 2007 - 23:07:35 GMT -

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Forex - Strong Payrolls Drives the EURUSD to 1 Month Low

DailyFX Fundamentals 01-05-07

By Kathy Lien, Chief Strategist of

• Strong Payrolls Drives the EURUSD to 1 Month Low
• Carry Trade Liquidation Continues to Benefit the Yen
• Canadian Unemployment Rate Drops to 30 Year Low

US Dollar
So far January has proven to be a very positive month for the US dollar. With this morning’s uniformly strong non-farm payrolls report, fundamentals, technicals and seasonality are now all on the dollar’s side. Job growth in the month of December was exceptionally strong, which means that the Goldilocks economy may be here to stay. Not only did the 167k increase in payrolls undermine the reliability of the ADP, Hudson Employment index and reports, but payrolls for the prior month were also revised higher for the seventh month in a row. We were most impressed by the strong gain in average hourly earnings, which rose by 0.5 percent and indicate that the strength in the labor market is real. For the time being, this gives the Federal Reserve the justification it needs to keep interest rates on hold at 5.25 percent. As the economy chugs higher while oil prices move lower, there is no reason for the Federal Reserve to rush to change interest rates. In fact, if retail sales also come out stronger next week, we could see a nice rebound in first quarter GDP growth. Retail sales and the trade balance are the only key pieces of data on next week’s calendar. Both of the reports are expected to show weakness compared to the prior month, but like the payrolls report, they have the risk of surprising to the upside. A strong labor market does wonders for the economy by fueling consumer spending. Retailers have suggested that holiday sales were not strong but with consumers forming long lines on a daily basis for Sony and Nintendo’s new gaming consoles, we doubt that spending could have been that weak.

The EUR/USD is trading at a one month low after dropping close to 300 points over the past three trading days. The European data released this morning was not hot enough to keep the currency pair from breaking down on the back of the stronger US numbers. Despite an impressive German labor market report earlier this week, retail sales may not have been as strong. The German retail PMI report dropped from 57.7 to 55.2 in the month of December. However the German retail sales numbers due out next week are for the month of November and not December. After the drop in October, there has to be a bounce, especially after business confidence hit a 16 year high since it is unlikely that businesses would be so optimistic if retail sales were not decent. The rest of the data was mixed. Overall Eurozone retail PMI also fell from 53.7 to 52.1 while producer price growth remained flat. The only positive was the improvement in consumer confidence from -7 to -6 in the month of December. In the week ahead, there continues to be a lot of Eurozone data due for release. This includes the GDP forecast, inflation reports, trade reports as well as the European Central Bank’s rate interest rate decision. No rate hikes are expected, but ECB President Trichet will be speaking in the press conference afterwards. It will be interesting to see if he changes his inflation outlook given the recent drop in oil prices.

British Pound
With only housing market data due out today, the GBP/USD has fallen victim to overall dollar strength. Over the past 3 trading days, the British pound has fallen by 445 pips. Having been one of the currencies that rallied the most on end of November dollar weakness, it has also been one of the currencies that has fallen the most on dollar strength. House prices also did not help either as they dropped 1.0 percent last month according to Halifax. The market expected prices to rise for 1.0 percent and even though the index can be volatile, the drop has caught the market by surprise since it stands in stark contrast to other housing market reports that have been released as of late. In the week ahead, the UK calendar is very busy. We are expecting retail sales, trade balance, industrial production and the Bank of England rate decision. Like the European Central Bank, the Bank of England is not expected to change interest rates. It should be a non-event however since the Bank of England does not make any comments when they leave their interest rates unchanged.

Japanese Yen
The Japanese Yen was the also the day’s best performing currency next to the US dollar. In fact, the Yen actually rallied against the US dollar despite the strong non-farm payrolls report. It seems that carry trade liquidation is still in full force. Japanese markets are closed on Monday again for “Coming of Age Day.” The economic calendar is very light with only second tier data due for release during the shortened trading week. This means that most Yen traders will be thinking about the following week’s interest rate decision (Nov 18). After raising interest rates last July, they have kept policy on hold for the past few months. They are expected to deliver their second rate hike on the 18th which means we could see more carry trade liquidation ahead of that.

Commodity Currencies (CAD, AUD, NZD)
The Australian and New Zealand dollars continued to collapse as gold prices fell again today. The Canadian dollar actually rallied thanks to the improvement in Canada’s labor market. The unemployment rate fell from 6.3 percent to 6.1 percent, a 30 year low. The 61.6k rise in employment turns 2006 into the second strongest year for job growth over the past 10 years. The IVEY PMI did not fare as well however as the index dropped below the 50 boom/bust level for the first time in 12 months. The strong labor market and recent drop in the Canadian dollar should help to boost economic activity going forward. In the week ahead, the Canadian calendar is light with some trade and housing market data due for release. Australia has comparably more data due for release including reports on trade, consumer confidence, and the state of the labor market. New Zealand on the other hand only has building permits on the calendar.


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