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Thursday, November 6, 2008

Why Non-Farm Payrolls Could Fall by 300K

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Daily Forex Fundamentals | Written by GFT | Nov 05 08 23:19 GMT |

TODAY'S BIGGEST PERCENTAGE MOVERS

  • AUD/JPY (-285 pips or -4.23%)
  • NZD/JPY (-215 pips or -3.45%)
  • CAD/JPY (-301 pips or -3.39%)

THE STORIES IN THE CURRENCY MARKET

  • USD: Why Non-Farm Payrolls Could Fall by 300K
  • EUR: Another 50bp Rate Cut Expected from the ECB
  • GBP: Risk of 1% Rate Cut from BoE
  • CAD: Oil Prices at $65 a Barrel
  • AUD: Sells Off Despite Mixed Economic Data
  • NZD: Employment Report Due for Release
  • JPY: Dow Drops 486 Points, Carry trades to Follow Suit

EXPECTATIONS FOR UPCOMING FED MEETINGS

GFT Forex

** PERCENTAGES MAY NOT ADD UP TO 100% BECAUSE OF THE PROBABILITY OF LARGER OR SMALLER MOVES BEYOND THOSE SHOWN ON THIS TABLE

US DOLLAR: WHY NON FARM PAYROLLS COULD FALL BY 300K

The sweeping victory of Barack Obama in the US Presidential Race has been the biggest story of the day. Obama supporters are ecstatic, but the financial markets are not. The Dow Jones Industrial Average dropped close to 500 today while the reaction in the US dollar has been mixed. Considering the big drop in US equities, carry trades have held up well. With one major uncertainty out of the picture, the markets have quickly turned their attention back to the economy. Although Obama has been synonymous with the hope for change, many people are beginning to realize that turning around the US economy will be a seismic challenge for the new President.

Implications of ObamaNation on the FX Markets

Based upon a previous study that we have conducted, over the past 30 years regardless of what party wins the elections, the US dollar tends to appreciate in the 6 months following the election. However the US economy is in the worst shape since the Great Depression, which was nearly 80 years ago. Like many of his predecessors, we expect Obama to do no more than pay lip service to the strong dollar policy. The dollar has already strengthened significantly and it would be counterproductive to engineer further strength in the greenback. In order to turn the US economy around, a weaker and not stronger currency is needed. In this economic environment, Obama will have no choice but to boost government spending and adopt more protectionist policies, which could hurt the US dollar. Even though Obama has given the country renewed hope, he won't be able to deliver any change for the financial markets until he becomes President on January 20th and even then, it will take time for him to implement new policies. Therefore the recessionary trade is still on and US interest rates are headed lower.

Non-Farm Payrolls Should be Ugly

In the meantime, all eyes will turn to Friday's non-farm payrolls report. The leading indicators for NFP are in and so far, all signs point to a very large drop in non-farm payrolls. The market is currently expecting NFPs to fall by 200k, but traders should not rule out the growing possibility of payrolls dropping by 300k. There is every reason to believe that the US labor market deteriorated significantly last month. Planned layoffs by US corporations hit a 5 year high while the employment components of service and manufacturing ISM fell deep into contractionary territory. Even the ADP report posted a 157k drop in private sector payrolls. US companies have made large scale cutbacks in anticipation of a sharp deterioration in growth and this has translated into major layoff announcements across the nation. In the past 3 decades, there has been 3 recessions and in each of those recessions, there was at least one month where non-farm payrolls fell by more than 300k. Given that this downturn is worst in almost 80 years, there is no reason to believe that this time will be different and that the US economy will be able to avoid a single month job loss of more than 300k.

Fed Changes Formula on Paying Interest

The Fed has been struggling to put a floor under the fed funds rate but so far, their efforts have not worked. This has forced them to change the formula for paying interest on reserves. Prior to their announcement today, the interest paid on reserves was 10bp below the Fed funds target average rate and now interest is being paid at the average rate, which basically means that they have increased the amount of interest that they are paying on the reserves. Even though the credit markets have been improving, the central bank and the US Treasury are still having a tough time encouraging lending. As a result, don't expect today's the change from the Fed to be their last.

EUR/USD: ANOTHER 50BP RATE CUT EXPECTED FROM ECB

The biggest event risk this week for the Euro is the European Central Bank interest rate decision. Weak economic data and softer inflationary pressures will force the ECB to take interest rates below 3 percent. A rate cut will not be a surprise since ECB President Trichet warned a few weeks ago that he plans on reducing rates at the November monetary policy meeting. As a central banker, Trichet is notorious for preparing the market for any imminent changes to monetary policy in the hopes that it will reduce volatility in the financial markets when the actual change occurs. Another 50bp point rate cut is expected and with the strong possibility that a recession is already underway, there may be a need for further rate cuts. We expect Trichet to retain a dovish tone as he proceeds to close the gap between US and Eurozone interest rates which should be Euro bearish. Downward revisions were reported in the final October purchasing managers indexes for Germany, Italy and France while Eurozone retail sales declined by 0.2 percent in September. As an export dependent region, a contraction in manufacturing activity spells big trouble for the overall economy. With interest rates expected to fall to 2.5 percent over the next 12 months, the Euro will have a tough time moving back above 1.35.

GBP/USD: RISK OF A 1% RATE CUT

Like the European Central Bank, the Bank of England will also be making a decision on interest rates tomorrow morning. However the difference between the ECB and the BoE is that we could see a much larger interest rate cut from the UK. To be clear, the official forecasts for both central banks is a 50bp rate cut, but the word on the street is that the BoE could cut by as much as 100bp. For the UK central bank, a larger interest rate cut will depend upon how proactive the central bank wants to be. Economic data has been very weak with the service sector PMI index falling to a record low. Even though consumer confidence edged higher, industrial production dropped for the 5th consecutive month. In October, the UK government openly admitted that the country has fallen into a recession. The European Commission believes that of any other mature European Union economy, the UK will suffer the sharpest contraction in growth. We expect the Bank of England to cut by at least 75bp. A 50bp rate cut would be a big disappointment while a 100bp rate cut is exactly what the market needs. Either way, the outcome of the BoE rate decision should be pound bearish. Over the next 12 months, UK interest rates could fall to below 3 percent.

DOW DROPS 486 POINTS, CARRY TRADES TO FOLLOW SUIT

Carry trades have trailed the move in equities today. In the past, the 486 point drop in the Dow would have led to a sharper decline in the Japanese Yen crosses. However we expect the Nikkei to follow the US equity markets lower, which should drag carry trades down as well. The problems in the US economy will come to forefront later this week with the US non-farm payrolls report due for release. The data should provide further evidence of the recessionary conditions in the US economy. We continue to expect the Japanese Yen to outperform all of the major currencies going forward as risk aversion remains the predominant theme in the financial markets. The minutes from the Bank of Japan monetary policy are due for release this evening. This will shed more light on the reasoning behind the central bank's latest rate cut and could provide more information on whether Japan could return to a zero interest rate policy.

AUSTRALIAN, NEW ZEALAND AND CANADIAN DOLLARS HIT BY RISK AVERSION

The Australian, New Zealand and Canadian dollars have been hit by a wave of selling as equity and commodity prices turn lower. Crude prices are now trading at $65 a barrel, which is off its recent lows but still represents a 55 percent decline from its July peak. Australia reported a stronger trade balance last night, but a sharp decline in the service sector PMI report and building approvals. Employment numbers are expected from Australia and New Zealand this evening along with the Canadian IVEY PMI report. We expect weak labor market reports that will confirm the need for further rate cuts in Australia and New Zealand. As for the IVEY PMI, the drop in leading indicators points to weakness for the key Canadian report.

GBP/USD: Currency in Play for the Next 24 Hours

GBP/USD will be the currency in play for the next 24 hours. Traders are much awaiting tomorrow's BoE Rate decision scheduled for 7:00am ET or 12:00 GMT.

Technically, GBP/USD price action is on the border between the Bollinger band sell and neutral zone. It has backed off of an earlier 250 pip rally, as it has since returned to the one-standard deviation Bollinger band. As resistance, we will use the 10-period simple moving average lying at about 1.600, as well as the 23.6% retracement of the late-September highs to mid-October lows. This creates a range between 1.600 and 1.6066. As support we will use yesterday's low of 1.5600, which of course will be back by lows placed October 24th. For several days we have seen the pair unable to sustain itself within the neutral trading zone and above the 10-day SMA. A significant close above these levels may be followed by rallies to October 30th highs.

GFT Forex

Kathy Lien
http://www.gftforex.com

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