NFP can only be strong..if not.. then..

Wake up and smell the coffee, Trichet seems to be. Bernanke stands well behind the curve and risks destabilizing the economy when he finally wakes up to the fact that strong growth and loose monetary policy ‘is’ inflationary.

Trichet followed in the hawkish footsteps of his coworkers yesterday and plied the EUR with enough ammo, at least until payrolls this morning, to dominate the non-inflationary Bernanke effect. The ECB will take the fight to inflation, maybe as early as next month.

Not to become punch drunk on prices, he watered down his tone by ‘not’ signaling the start of a series of rate increases. Against a backdrop of strong growth and above target inflation, reasons enough for the ECB to begin its tightening bias, the periphery issues will be dealt with later it, so it seems.

The market waits for a strong NFP print. There can be ‘no’ other number (expectations of +200k).The improvement in the employment component of both ISM surveys is consistent with a stronger print and an unemployment rate to tick back up to +9.2% as better news should draw more job seekers back into the labor force. On a stronger-than-expected release, the market will expect renewed out-performance from currencies that are higher-yielding proxies for US growth. A disappointing number and the EUR will be King.

The US$ is mixed in the O/N trading session. Currently, it is higher against 12 of the 16 actively traded currencies in a ‘subdued’ O/N session ahead of the employment report.

Forex heatmap

The drop in US weekly claims yesterday is definitely good news for the labor market, but, will have nothing to do with today’s NFP. Claims fell by -20k to +368k, the lowest level in nearly two years. The less volatile four-week-moving-average now stands at +388k (well below the psychological +400k print). This year’s downward trend remains in tact, despite the intra-weeks modest gains and losses.

It’s worth noting that President’s Day may have caused some distortions, do not be surprised to witness an upward correction next week. Digging deeper, the revisions were modestly lower, however, both continuing claims (-59k) and emergency benefits (-32k) retreated while the extended benefits provided the partial offset, with a gain of +89k.

US ISM non-manufacturing was not much of a surprise, coming in at 59.7 last month, just above market expectations. However, it’s the strongest reading since August 2005. The headline print is proof that the service growth appears to be finally entering a ‘self-sustaining’ pattern. The market will be hoping that it can take over from the manufacturing sector and be the driving force for growth and the overall recovery.

It’s worth noting that the strong employment index reading bodes well for this morning’s payroll number. The employment index rose from 54.5 to 55.6, the best in four-years. This implies a strong private non-manufacturing sector payroll reading of +230k this morning. It’s worth remembering that the correlation has not been the strongest of late.

Digging deeper, the business activity index rose from 64.6 to 66.9 (best reading in six-years). A tad disappointing was the forward-looking new order index dipping to 64.4 from 64.9. The prices paid component continues to edge higher to 7.3 from 72.1, the strongest reading in two and a half years.

The USD$ is higher against the EUR -0.07%, GBP -0.23% and JPY -0.10% and lower against CHF +0.07%. The commodity currencies are weaker this morning, CAD -0.13% and AUD -0.17%.

The loonie waits for this morning’s payrolls release just like all the others. The currency is hanging tough despite Governor Carny’s views on an elevated loonie price and on commodities retreating yesterday. Earlier this week the BoC held rates steady at +1%. The event risk was that the Governor would try to talk down the currency’s rise. The operative word is he ‘tried’. In their communiqué, the BoC expressed its concern about the strength of the loonie ‘the export sector continues to face considerable challenges from the effects of the persistent strength in the Canadian dollar and Canada’s poor relative productivity performance’. The new reality is a Canadian dollar at or close to parity as the economy adjusts to this paradigm.

The market has preferred been long this currency for both risk averse and commodity supporting reasons. However, Governor Carney is in no rush to raise interest rates, stressing as before that ‘any further reduction in monetary policy stimulus would need to be considered carefully’. If the Bank really was contemplating an early rate hike, would we not expect the forward looking guidance to be altered? (0.9732)

The Aussie dollar remains soft, extending this weeks decline outright, on expectations that a big US payroll number this morning will reduce the yield advantage between the two nations. The currency has slid to a six-week low vs. the EUR on fear that Trichet and Co. will raise interest rates faster than the RBA this year. However, Australian fundamentals continue to support a higher policy rate environment, and a currency appreciating medium term.

Analysts note that the Australian economy finished last year with ‘strong’ momentum and despite severe flooding affecting first quarter 2011 GDP growth, futures dealers anticipate a solid uplift in growth for the first half of the year. The RBA, this week, has noted that mildly restrictive rates are appropriate. The futures market is pricing in further modest tightening starting in third quarter as the data strengthens and the threat to inflation rises along with commodity prices and higher wage growth. Commodity prices continue to provide support on pull backs.

Next question, is this growth sustainable in a higher oil price environment? Expect the RBNZ actions to weigh on Governor Stevens monetary policy thinking.

Crude is higher in the O/N session ($102.60 +69c). Yesterday, Crude prices dropped the most in a week after reports that the Arab League is studying a plan to end the violence in Libya. However, prices remain elevated on Middle-East geopolitical concerns and this despite the Saudis offering to make up for supplies lost. Contagion fears continue to price in a substantial risk premium. Oil has surpassed its 30-month high of last week on concerns of further supply disruptions. ‘The IEA’s chief economist said that ‘higher oil prices pose a danger for a global economic recovery’.

Last week’s EIA report again has provided some support for the US crude market on pull backs. The report showed a smaller-than-expected increase in supplies. Crude inventories fell by-364k barrels to +346.4m vs. an expected increase of +750k. Even worse was the gas inventory headline declining, stocks plummeted -3.59m barrels to +234.7m, greatly exceeding market expectations for a-400k draw. Inventories at Cushing rose by +1.13m barrels to a record +38.57m.

This rise is partly responsible for the wide discount of WTI to Brent crude in recent weeks. Distillate stocks (heating oil and gas) fell-751k barrels to +159.1m, less than analyst expectations for a decline of -1.2m barrels. Refinery utilization rose +1.5% to 80.9% of capacity. The Oil market is beginning to show signs of ‘demand destruction’ as high prices erode consumption. With supply the number one concern, the commodity will remain bid because of the contagion concerns.

Gold retreated from its record high yesterday as Chavez, the world’s most unlikely go-between, offered his services to mediate a resolution to the crisis in Libya. Any hopes of peace will be bearish for commodities and price action is clearly highlighting some profit taking. Last week the commodity was up +1% and is on course to beat that by day’s end. The yellow metal continues to be supported by geopolitical factors and inflation threats. Prices have risen nearly +7% this month, as investors have grown increasingly uneasy that the crisis could spread.

Even hawkish global rhetoric has managed to give the yellow metal a leg up in February. Consumer prices are also boosting the demand for the precious metal as a hedge against global inflation. Last week, the market witnessed Chinese’s inflation accelerating the most in six years, and UK consumer prices the most in two years. Even US data is showing that their inflation numbers are edging higher. This week’s European PPI accelerated more than forecasted in January. China is supporting the commodity’s outright, purchases in the country climbed to 200 metric-tons in the first two months of this year. With the commodity being used as a store of value the asset class is expected to remain better bid on deep pullbacks, at least until there is peace ($1,420 +$4).

The Nikkei closed at 10,693 up+108. The DAX index in Europe was at 7,285 up+59; the FTSE (UK) currently is 6,041 up+36. The early call for the open of key US indices is higher. The US 10-year backed up 9bp yesterday (3.54%) and is little changed in the O/N session.

TIPS have pushed the US yield curve higher, indicating the fastest pace of price increases in two and one-half years. A compounding effect was US initial weekly claims unexpectedly declining. The tens/TIPS spread is at +249bps. The FI market seems to be fearing a larger than expected payroll print this morning and this despite the geopolitical concerns in the Middle-East.

Earlier this week, US yields were in danger of being too low to sustain demand for US debt as the Fed approaches the end of its second round of QE. This morning’s NFP, Bernanke’s QE2 thoughts from this week, coupled with a ‘weekend’ insurance premium will keep us guessing.

This article is for general information purposes only. It is not investment advice or a solution to buy or sell securities. Opinions are the authors; not necessarily that of OANDA Corporation or any of its affiliates, subsidiaries, officers or directors. Leveraged trading is high risk and not suitable for all. You could lose all of your deposited funds.

Dean Popplewell

Dean Popplewell

Vice-President of Market Analysis at MarketPulse
Dean Popplewell has nearly two decades of experience trading currencies and fixed income instruments. He has a deep understanding of market fundamentals and the impact of global events on capital markets. He is respected among professional traders for his skilled analysis and career history as global head of trading for firms such as Scotia Capital and BMO Nesbitt Burns. Since joining OANDA in 2006, Dean has played an instrumental role in driving awareness of the forex market as an emerging asset class for retail investors, as well as providing expert counsel to a number of internal teams on how to best serve clients and industry stakeholders.
Dean Popplewell