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Forex - Euro: A Repeat of December 2004?

DailyFX Fundamentals 05-02-07

By Kathy Lien, Chief Strategist of DailyFX.com

• Euro: A Repeat of December 2004?
• US Labor Market Data Signals Softer Non-Farm Payrolls
• Further Aussie Weakness Contingent Upon RBA Statement

US Labor Market Data Signals Softer Non-Farm Payrolls

Despite softer labor market numbers this morning, the rally in the US dollar suggests that the market is fully focused on tomorrow’s service sector ISM report. The upside surprise in ISM manufacturing yesterday and today’s strong rally in the stock market has everyone banking on stronger service sector growth in the month of April. The low 53.1 forecast will not be hard to beat and there is a decent chance that we could see improvements in the employment and prices paid components as well. With non-farm payrolls due out this Friday, we will be watching the employment component of ISM services very closely. The labor market data released today painted a grim picture for payrolls. Challenger Gray and Christmas reported an 18 percent increase in announced layoffs in the month April and a 44 percent increase in planned layoffs. The ADP national employment report also fell short of expectations, with private sector payrolls rising 64k instead of the 100k expected. Therefore even though corporate earnings have been strong, the softness of GDP last week has many corporations worried that demand could falter in the months to come. As a result, hiring could be limited, which would support the market’s softer payrolls forecast. If job growth is weak, concerns about a soft landing and stagflation could resurface. Meanwhile, the manufacturing sector is continuing to improve after factory orders jumped by 3.1 percent in March. Even though the manufacturing sector could still report job losses in the month of April, the trend should be reversing.

Euro: A Repeat of December 2004?

In yesterday’s Daily Fundamentals, we had pointed out that the peak in the EUR/USD in December 2004 was triggered by a series of disappointing economic data. Today we get a sense of déjà vu as we are beginning to see the same scenario unfold once again. Earlier this week, German retail sales dropped significantly and this morning, we saw German unemployment and Eurozone manufacturing PMI all fall short of expectations. Originally expected to drop by 40k, unemployment instead only dropped by 9k, leaving the unemployment rate unchanged at 9.2 percent. The Eurozone PMI manufacturing survey was also originally expected to increase, but it remained unchanged. Aside from the German retail number, these disappointments are not significant. Nonetheless, it does indicate that the combination of a strong Euro and the value added tax increase is beginning to have a negative impact on the Eurozone economy. We are already looking for more Euro weakness than strength though in the short term, that would be dependent upon US data. However if the mild disappointments start to become serious ones, then we could see a major trend reversal in the EUR/USD. In the meantime, ECB officials remain committed to raising interest rates. ECB member Liebscher said today that the central bank needs to remain vigilant to ensure price stability. Over in Switzerland, even though the Swiss franc is stronger, manufacturing PMI also fell short of expectations.

Strong Housing Data Already Baked In, British Pound Sells Off

Despite multiple indications that UK housing sector growth remains hot, the British pound has eased back over the course of the day to the 1.9900 level. PMI construction unexpectedly surged to 59.8 - the highest level in more than three years - as housing activity and employment growth both picked up. Meanwhile, although mortgage approvals eased back to 113K from a downwardly revised 117K, the figures still remain relatively lofty and signal robust demand for home loans. Other types of borrowing grew as well, as consumer credit kept pace at 0.9 billion pounds, led by a gain in credit card lending. This has all helped contribute to M4 money supply expansion of 12.8 percent for the year, which will likely remain a major concern of the Bank of England. With little in the way of major UK releases over the next few days, GBP/USD price action could continue to be paced by the US dollar.

USD/JPY Rallies Alongside the Dow; Paulson Toughens Stance on China

With no significant data released, we saw mixed performance in the Japanese Yen. The rally in the Dow has helped to send EUR/JPY, CAD/JPY CHF/JPY and USD/JPY higher. The problem is that not all of the high yielders are participating in the move as AUD/JPY and NZD/JPY are both unchanged on the day while GBP/JPY sold off. The divergent price action could be foreshadowing an end to the rally in the stock market, but it is a bit too early to tell. Meanwhile most Japanese traders are still out of the office celebrating the Golden Week holidays. Comments by Treasury Secretary Paulson are worth noting. In a shift away from his usual buddy over bully approach, Paulson warned that there would punitive trade proposals against China if they did not institute some FX and economic reforms immediately. It is clear that the US is taking a very different approach on China and it is only a matter of time before see another major development on the country’s foreign exchange or trade policies, which would have a beneficial impact on the Japanese Yen.

Further Aussie Weakness Contingent upon RBA Statement (AUD, NZD, CAD)

The Australian and New Zealand dollar both ended the day mildly higher against the US dollar, as the Reserve Bank of Australia's decision to leave rates steady at 6.25 percent proved to be a non-event. However, tomorrow evening could be crucial for Aussie trade as the central bank's Monetary Policy Statement is set to be release and will include outlooks for growth and inflation this year, helping to gauge the RBA's bias. The Canadian dollar held up even better against the greenback today, though USDCAD declines stalled near 1.1080 ahead of major event risk Friday when Ivey PMI will hit the tape. Estimates are for a decline following an unexpected surge during the month prior, but nevertheless, the US NFP report will likely dominate USDCAD trade that day.

 

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