It was a busy week in the foreign exchange market that ended with a bang on Friday – we’ll start by talking about the U.S. dollar and non-farm payrolls but the big story of the day/week/month is the British pound. Sterling dropped more than 5% in the blink of an eye during the Asian trading session on low liquidity and thin trading conditions. Unfortunately the existence of algos and leveraged players exposes the market to a greater frequency of big moves like these. In many ways the shockingly fast decline overshadowed the non-farm payrolls report by causing more volatility in currencies. However the flash crash may turn out to be just that whereas the U.S. jobs report should have a more lasting impact on the dollar and Fed policy.
For the second month in a row, U.S. labor data disappointed in a very big way. Only 156K jobs were created in the month of September, down from a revised 167K number in August. This sluggishness in job growth drove the unemployment rate up to 5%, the first increase in 6 months. Average hourly earnings growth increased but less than economists anticipated. Given how quickly and aggressively USD/JPY appreciated, today’s report was soft enough for profit taking. The Fed won’t be able to justify a December rate hike if NFPs fail to rebound to 200K or more next month. This thinking should weigh on the dollar in the week ahead and we would not be surprised if USD/JPY found its way below 102.40 and even down to 102. However if USD/JPY gets down to 102 it becomes an attractive buy because the Federal Reserve will still be raising interest rates and December remains an option – we just need to shake out some longs before that happens.
It should be a quiet trading day on Monday with U.S. markets closed for the Columbus Day holiday so further profit taking is likely. The greenback will remain in focus in the week ahead with the FOMC minutes, U.S. retail sales and University of Michigan Consumer Sentiment index scheduled for release. Investors will be paying close attention to the speeches from U.S. policymakers. There are no less than 7 U.S. policymakers including Yellen, Dudley, George, Rosengren and Evans scheduled to speak and if they try to downplay the latest jobs number the dollar could recover. We heard from Fed Vice Chair Fischer and President George after the data and both expressed continued satisfaction with the labor market with Fischer indicating that the “rise in unemployment and participation rates is still fine.” The main focus will be on Yellen and if she backpedals on the need for a rate hike, then the dollar could extend its slide down to 101.50.
Friday’s flash crash in sterling set a new range for the currency. Previously, many believed that GBP/USD would find support at 1.25 but that level is now resistance and support is likely to become 1.22 and in the worst case 1.20. Even before the abrupt sell-off sterling was under significant pressure. Some market participants blamed the meltdown on comments from French President Hollande who said Britain must wear the consequences of leaving the EU but the speed and magnitude of the decline indicates otherwise. Hollande’s comments could have driven the pound lower by 30 to 50 pips max but certainly not 700 pips. This move can only be driven by a major event risk (which there was none) or a large multi-billion sterling sell order that took out many layers of stops and option barriers in the process. We may or may not learn about this order in the future but that is the only explanation for Friday’s move. Considering that fundamentals support a weaker currency, we expect GBP/USD to trade in a new lower range and investors shouldn’t hope for any help from the Bank of England who is probably delighted to see this recent weakness in the currency. No central bank likes big moves but after the initial decline GBP/USD rebounded and is now down only 1.5%. A weaker sterling goes a long way in boosting inflation, supporting trade and tourism – 3 areas of the economy that need help. With no U.K. event risk on the calendar, GBP/USD is vulnerable to a short squeeze next week but between Brexit and the flash crash the market has completely forgotten about this past week’s stronger PMI reports that showed manufacturing, service and construction sector activity accelerating. These 3 areas of the economy received another in shot in the arm from the plunge in the currency so if Prime Minister May plays her cards right and limits Brexit headlines for the next week, we could see a relief rally.
Even though EUR/GBP shot to a 7 year high, the euro ended the week lower against the U.S. dollar. That move had little to do with Eurozone data even though most of the economic reports released last week was relatively subdued. For the most part, Deutsche Bank stayed out of the headlines but U.S. dollar strength and then sterling risk aversion took the currency pair to its lowest level in nearly 3 weeks. There was a bit of excitement midweek courtesy of a report that said the ECB was nearing a consensus on the need to taper Quantitative Easing before it concludes. This sent EURUSD briefly higher but central bank President Draghi was quick to deny the statement saying tapering was not discussed and this was confirmed later by ECB member Constancio. Tapering before ending QE is not unusual process but investors were surprised by a headline that focused on tightening and not easing. Either way, the impact was shortlived as the EUR/USD took its cue from the dollar. Germany’s trade balance and ZEW survey are scheduled for release next week but these reports are not expected to have a significant impact on the currency. Technically 1.12 remains the key resistance level for EUR/USD.
Unlike the U.S, Canada report very strong jobs data. More than 67k jobs were created in the month of September, the largest increase since April 2012. There was a decent mix between full and part time work, which helped to lift the participation rate to 65.7%. Manufacturing activity also accelerated quickly with the IVEY PMI index jumping to 58.4 from 52.3, the highest level since January. Given these reports we are a bit surprised by the weakness of the Canadian dollar particularly in light of the lower non-farm payrolls report. Oil prices only fell slightly so that can’t explain the weakness. USD/CAD did trade lower initially but recovered its losses quickly. We believe that a deeper correction is in store with a potential move down to 1.3150. However with no Canadian economic reports scheduled for release next week, CAD flows will dictated by oil.
The Australian and New Zealand dollars also had a tough week even though there unchanged against the U.S. dollar on Friday. The Reserve Bank of Australia left interest rates unchanged at 1.5% and the statement had a cautiously neutral tone. The RBA felt that recent labor data was mixed, noting that although the unemployment rate declined and indicators point to a growing labor market, the issue lies with growth being seen in part time jobs, with full time job growth being somewhat subdued. They also expressed concern about low inflation and China. This was the first central bank meeting as Governor for Phillip Lowe and having previously served as deputy governor, he did a good job of limiting market volatility around the rate decision. Recent Australian data has actually been good with manufacturing and service sector activity accelerating. The trade balance also narrowed and retail sales increased but AUD/USD is taking its cue from risk appetite and the greenback – two forces that will remain key drivers for AUD next week. There are no Australian economic reports on the calendar in the new week but China’s trade balance and U.S. retail sales will have the most significant impact on the currency. In contrast, lower dairy prices added pressure on the New Zealand dollar. For the first time since August, prices fell at an auction, validating the central bank’s concerns for the economy. New Zealand manufacturing PMI numbers are scheduled for release next week and we expect NZD/USD to remain under pressure.