- “Trade of a lifetime” eases up
- Mixed messages on Greece pressures EUR
- Can U.K. Conservatives win a surprise majority?
- Dollar bears look to bunds for support
The U.S. bond bear can breathe a little easier heading into this morning’s nonfarm payrolls (NFP) number. However, at one point yesterday during the European session it was looking very bleak with U.S. 10s backing up to its new 2015 high yield at +2.32%. Since April, the heavy selling in U.S. Treasurys came mostly on the back of the rout in Euro bonds. Yes, U.S. data has not been great, but the rates are higher this week for reasons that are not directly related to the Federal Reserve or the U.S. economy.
European government debt markets are usually considered relatively stable with intraday yields moving only a few hundredths of a percentage point a day. In under three weeks, the “trade of a lifetime” saw 10-year bund yields rally +75 basis points from record low yields (+0.05%). Yesterday alone the yield surged +21 basis points to +0.80% (its highest level since last November) before easing back below +0.60% as hedge funds immediately stepped in to pare positions ahead of NFP. Interestingly, European peripheral yields saw weaker gains and tightened significantly to bunds as corporate buyers finally appeared. There seems to be no apparent cause for the yesterday’s intraday spike, besides a general lack of liquidity. Because German bund yields act as a benchmark for European financial markets, the violent yield moves have led to a seismic shift in multiple asset classes — Dax down -9% and the EUR up +5% against the dollar since April 10.
EUR Loses That Loving Feeling
The EUR outright has retraced from yesterday’s fresh weekly high of €1.1391, pressured by a number of factors. First, and to be expected, there continues to be mixed messages delivered on Greece. There was yet another significant negative headline delivered by the European Union head Jeroen Dijsselbloem who suggested that it’s unlikely a deal can be reached on Monday. The ultimate deadline for the country is the end of June when the latest rescue plans ends. Nevertheless, this deadline is moot if the country runs out of cash and next Tuesday, and there is a small matter of +€750 million owed to the International Monetary Fund.
Second, event risk encouraged many investors to pare positions and some cashed in USD and GBP short profits. That sent the single unit sub-€1.1250 and €0.7400 in the event that that NFP was going to trump this week’s ADP return, and if the U.K. general election results could provide a positive surprise. Prime Minister David Cameron’s very strong showing offers continuity for investors (Conservatives looks poised to possibly win an outright majority in a stunning victory). The expectations of a hung parliament would have lead to days or weeks of political bargaining. With that possibility now remote, it is being priced out and has given sterling fresh legs for now £1.5460. However, questions over Scotland and Europe will eventually return and haunt the pound and London, but that’s for another day.
What To Expect From NFP Data?
Investors have been trying to avoid taking any lopsided positions ahead of this morning’s jobs report. Yesterday’s U.S. weekly claims were strong enough to keep alive some investors’ expectations for upbeat numbers in this morning’s NFP report. The weekly unemployment claims for the week ended May 1 came out at +265,000 (+280,000 expected), lifting the greenback and sending the pair to fresh intraday lows around €1.1200.
The massive position adjustments this week certainly suit a positive dollar reaction to NFP (+223,000 +5.4% unemployment expected). If the report meets expectations, the Fed should be happy to see the U.S. economy getting back on track after a disappointing first quarter. It would solidify market expectations that rate hikes are on the cards for later this year. Fixed income/futures are backing a September hike and any variations above or below jobs consensus would obviously shift expectations around that date.
This week’s violent price action across the board has managed to clear out most of the weaker dollar long positions, despite higher U.S. rates prevail, with rate divergence being the premise for initiating these long dollar positions in the first place. The USD bulls will be anticipating yields to be driven higher with a stronger headline print. They are expecting U.S. 10s to back up to +2.50% rather quickly. It’s a bit of a stretch from current levels since U.S. 10s has given up nearly -18 basis points since yesterday. But in the medium term, it’s very possible. The USD should be able to find this week’s lost luster against Group of 10 currencies rather quickly given the depth of neutral positions being currently held.
Dollar Bears Not Giving up Hope
The dollar naysayers believe support is on their side. Wednesday’s April ADP report does not bode well for a stronger April U.S. jobs print. The ADP numbers widely missed expectations (+169,000 versus +205,000 expected) and fell to their lowest level in 18 months. Virtually all the job gains were in small and midsized businesses, and were almost all in the service sector with manufacturing losing a small number of jobs.
It marks the second month that headline print was below expectations, which of course signified the U.S. government reported a big miss for March (+126,000). The correlation between the two reports is historically not that strong. However, a miss would suggest there’s some evidence to add to downside risk.
The report indicated that falling oil prices and a stronger dollar is taking a toll on hiring plans. Another soft NFP headline print will take a June hike off the table and certainly leave a September hike very much in doubt. Investors should be expecting the USD to give back and then some, the traction that banked in the past day.
The EUR will be expected to take on the €1.1400 handle sooner-than-expected. U.S. yields should come under pressure, as investors will be expecting ‘lower-for-longer’ Fed rates. However, this week’s yield moves have been dominated by bunds, and the market consensus believes that trade is not finished yet. Poor market liquidity may increase distress in cases, and the U.S.-bund spread trade remains vulnerable.