NEWS / Foreign Exchange

Forex- Fed Could be Holding Out for Payrolls

DailyFX Fundamentals 08-02-06

By Kathy Lien, Chief Strategist of www.dailyfx.com

- ECB Expected to Raise Rates - Euro Traders Should Watch Trichet??™s Press Conference
- Fed Could be Holding Out for Payrolls
- Yen Rises on More Hawkish BoJ Comments and Speculation of Yuan Revaluation

US Dollar

As we mark time ahead of the European Central Bank??™s interest rate meeting tomorrow and Friday??™s non-farm payrolls report, the performance of the US dollar has been very mixed. The greenback registered gains against the Euro and Swiss Franc, but sold off slightly against the Japanese Yen, British pound and Canadian dollar. Handicapping last month??™s payrolls number is more difficult than ever. The leading indicators for July payrolls released today, despite their weakened reliability suggests that the number of jobs created last month could once again fall short of the market??™s expectations. The ADP employment number reported a 99k rise in jobs compared to a 368k rise in the month June. Although the number grossly over predicted payrolls that month, the lower number suggests the possibility of an even worse outcome. Over the lifetime of the report, it still has an 88 percent correlation with payrolls. The Hudson employment index also reported a 0.5 percent drop in the month of July. However despite these two disappointments, traders are optimistic about the potential payrolls outcome. The nonfarm payrolls derivative auctions have traders betting that 152,700 jobs were created last month. Like bears, bulls also have good reasons to be optimistic. Jobless claims remain extremely low while the employment component of the ISM report and other employment indices rebounded in the month of July. The current consensus forecast is that the economy created 145k jobs last month, 24k more than the month prior. Payrolls will be the last main report until the Federal Reserve meets on August 8th. With signs of a slowdown battling increasing inflationary pressures, any major surprises in payrolls could be the eleventh hour announcement that shifts the Fed??™s opinion. However in order to do so, we would need to see payrolls in excess of 150k or less than 110k. Even though the market is only pricing in a 30 percent chance of a rate hike next week, the probabilities should be more like 50 percent. Of the 51 analysts surveyed by Bloomberg, only 60 percent expect a pause, which is far from unanimous.


Euro

The main event tomorrow will be the European Central Bank??™s monetary policy meeting. The central bank is widely expected to raise interest rates from 2.75 percent to 3.00 percent. Today??™s slightly stronger annualized producer price figures continues to confirm the ECB??™s need to tighten monetary policy and we expect tomorrow??™s service indices across the Eurozone to do so as well. However, when it comes to the ECB, the interest rate hike is never the surprise. We have long said that the ECB likes to prepare the market for a move well in advance, which it has done this time around as well. The real unknown is the stance that ECB President Trichet will take at the press conference following the meeting. Yesterday, we said that if the Euro reached 1.29 before the ECB meeting, the chances for tamer comments from the ECB are high. The Euro has since sold off to 1.2780, but the risks still remain for slightly more neutral comments. The next ECB meeting after tomorrows is August 31st. With the global economy slowing, it may be too soon to deliver another dose of tightening. The ECB may also want to buy time as they wait to see what the Federal Reserve does first. If the Fed pauses, the ECB has much more leeway to follow suit. However do not be mistaken, the ECB is still expected to bring rates to at least 3.25 percent this year. Meanwhile Swiss economic data continues to outperform many of the other major countries. PMI in the month of July rose to 65.1, which was stronger than expected and continues to confirm the strength of the country??™s economy.

British Pound

After a five day winning streak, the British pound ends the day unchanged against the US dollar. Despite a stronger construction sector PMI report, the rally in the British pound has become very exhausted. The index increased from 50.8 to 53.2 in June, confirming the improvements that we have seen in many of the other housing market reports. However, this should do little to shift the Bank of England??™s solidly neutral monetary policy stance. Like the European Central Bank, the Bank of England will also be making an announcement on interest rates. They are expected to keep rates on hold at 4.50 percent and when they do not change rates, they do not issue any accompanying statements. In the long run though, the improvements in UK economic data suggest that the central bank will eventually opt to raise interest rates later this year. We expect this to happen when the central bank becomes full staff once again after the 2 new members join in September and October.

Japanese Yen

The Japanese Yen was one of the day??™s best performing currencies thanks to the combination of hawkish comments from yet another Bank of Japan official and speculation that the Chinese government could revalue their currency again over the next few weeks. Mizuno was the latest official to say that it is a mistake for the market to assume that there will be no more interest rate hikes this year. So far, similar comments have been made by Fukui and Suda. Their message could not be any clearer and as such, we expect the BoJ to bring rates to at least 0.5 percent by the end of the year. The BoJ appears to be adopting a similar tactic as the ECB of curbing exchange rate volatility by warning of pending moves far in advance. In terms of China, Xinhua news reported that the PBoC could increase Yuan flexibility. This comes after calls by Treasury Secretary Paulson for more currency flexibility in China. Paulson has strong ties with China and it is widely believed that he has been brought in to broker a Yuan currency regime that is satisfactory for both China and the US. His timing could not be any better as China becomes more frustrated with the difficult challenge of taming their double digit growth - they may be forced to resort to currency revaluation anyhow.