EUR: Beware of Profit Taking Ahead of ECB Next Week

• EUR: Beware of Profit Taking Ahead of ECB
• USD: Unfazed by Headline Disappoints in Payrolls
• GBP: Biggest One Day Slide Against EUR Since 2009
• Why NZD/USD is Doing Well
• AUD: Odds of Rate Cut at 50-50
• CAD:  Oil and Gold Up
• JPY: Yen Continues to Weaken on Disappointing Data

EUR: Beware of Profit Taking Ahead of ECB

The EUR/USD was on a tear today, taking out 1.36 and then 1.37 before backing off its highs to end the day up approximately 0.6% percent against the U.S. dollar.  The rally was kicked off by better than expected Eurozone data and more specifically upward revisions to German and Eurozone manufacturing PMI. It then gained momentum shortly after U.S. stocks opened for trading but fizzled after the London close.  The relentless rally in the EUR/USD has been nothing short of impressive. From its low of 1.2660 in November to its high of 1.3710 on Friday, the EUR/USD appreciated nearly 7.5%.  This strength also drove other euro pairs to multi-year highs. One of the greatest fears this year was for slower Eurozone growth and while growth has slowed in certain parts of Europe, Germany continues to carry the region on her shoulders.  How long this can last remains to be seen especially since the recent rise in the euro poses a risk for to Germany's export sector.  The EUR/USD also benefitted from the rise in U.S. stocks. The Dow Jones Industrial Average rose above 14k for the first time since 2007.  While risk on / risk off isn't having the same impact on the FX market as it did in the past (see the sell-off in the GBP and AUD), when traders are already bullish euros, the improvement in risk appetite helps to compound the rally.

With that in mind, there is a potential for some profit taking in the EUR/USD ahead of next week's ECB meeting.  Monetary policy is expected to remain unchanged but everyone will be listening carefully for Draghi's comments on the currency.  At 1.34, the ECB was comfortable with the level of the euro but do they feel the same way after the currency hit a high of 1.37? We believe that the central bank is getting fidgety but the pain threshold for the ECB should be between 1.38 and 1.40.  That is not to say that members of the EU (such as Juncker) or other non-ECB officials won't cry for help before that level is reached, but the comments that matter will be the ones from the central bank.  As the head of the ECB, Draghi has never commented on the value of the currency but his predecessor Trichet has.  When Trichet wanted to verbally intervene in the EUR/USD, he would call the move "brutal" and when he was worried but not ready to pull the trigger, he would say something more vague like, "excessive movements in FX rates have adverse implications." Unsurprisingly, the use of the word brutal had a more significant impact on the EUR/USD than excessive movements.  The point that we are trying to make is that if ECB President Draghi were to comment on the euro next week, the worst he will say is that excessive movements are undesirable.  Hopefully he'll be prepared because if the currency is not addressed directly in his prepared commentary, it will most certainly be asked in press conference with reporters.

USD: Unfazed by Headline Disappoints in Payrolls

The non-farm payrolls report always creates excitement for the financial markets but as anticipated, it yielded very little reaction in the U.S. dollar.  The data fell short of expectations with job growth slowing to 157k from an upwardly revised increase of 196k the prior month and the unemployment rate increased from 7.8% to 7.9%.  This disappointment initially drove the dollar slightly lower against all of the major currencies but at the end of the day, posed no major threat to the overall uptrend in the EUR/USD and USD/JPY.  Investors did not have a more exaggerated reaction because non-farm employment was revised sharply higher in October, November and December.  The rise in the unemployment rate is concerning but the main takeaway from today's report is that payrolls have been steady with no major acceleration or deterioration.  The U-6 unemployment rate, which is considered a broader measure of the labor market than the official number that is reported was also unchanged last month.   So while the Federal Reserve won't be happy to see job growth slow, the rise in the unemployment validates their plans to keep monetary policy easy for the foreseeable future.  With the Fed now targeting a 6.5% unemployment rate, the spread between the current level of joblessness and the central bank's target has widened.   Average hourly earnings growth also slowed to 0.2% from 0.3% while average weekly hours remained unchanged at 34.4.  Private sector payroll growth was slightly stronger at 166k as cuts in government jobs reduce the overall headcount increase.  Consumer confidence for the month of January was also revised higher while the ISM manufacturing index increased from 50.2 to a 9 month high of 53.1. The most important thing to remember about the NFP report is that the factors behind the relentless rally in the EUR/USD and USD/JPY haven't changed.  Eurozone economic data continues to beat expectations thanks to better than expected growth in Germany. The ECB is also beginning to reduce stimulus through LTRO repayments and as they continue to do so, liquidity in the Eurozone will decline at a time when the Fed will keep monetary policy unchanged, which will be positive for the EUR/USD.  Compared to Japan who will shift to open ended asset purchases next year and is expected to increase asset purchases this year when the new BoJ Governor takes office, steady monetary policy in the U.S. makes the dollar more attractive versus the Yen.

GBP: Biggest One Day Slide Against EUR Since 2009

The worst performing major currency today was the British pound, which dropped approximately 0.9% against the U.S. dollar and more than 1.5% against the euro.  The rally in EUR/GBP was the strongest one-day move since September 2009.  Stops were clearly taken out in EUR/GBP when it rose above 86 cents, driving both the euro higher and the pound lower. While weaker economic data can be blamed for the move, it was really fixing flows and stops that got sterling moving as quickly and aggressively as it did. There was also speculation that the U.K. could lose its AAA rating - a risk that we have written about often since the beginning of the year. Between the government's difficulty in meeting fiscal targets and softer economic data, one of the big 3 rating agencies (probably S&P) may feel compelled to cut the country's sovereign debt rating.  Meanwhile manufacturing activity in the U.K. grew at a slower pace in the month of January according to the PMI index, which fell from 51.2 to 50.8.  While the sector is still expanding overall because the index is above the 50 boom/bust mark, the slowdown won't make the Bank of England feel any better. Thankfully the details of the report weren't as grim as the headline number.  According to Markit, the agency that releases the report, output growth hit a 16-month high, which is an encouraging start for 2013. The Bank of England is scheduled to meet next week but no changes to monetary policy is expected.

Why NZD/USD is Doing Well

While the Australian and Canadian dollars ended the day slightly lower against the greenback, the New Zealand dollar climbed to a fresh year to date high against the U.S. dollar.  The outperformance of the NZD vs. the AUD and CAD is a perfect example of the importance of monetary policy expectations. Earlier this week, optimistic comments from the RBNZ convinced many NZD/USD traders that the next step for the central bank will be higher and not lower interest rates whereas some traders are looking for another rate cut by the RBA next week.  In a speech last night, RBNZ Governor Wheeler continued to sound positive.  He said global demand for New Zealand's commodities is strong and external debt means that New Zealand needs higher rates than other countries. Wheeler is also making his focus on the housing market very clear - if prices continue to rise, the central bank could start talking about raising interest rates.  There was no economic data from Canada but the AUD/USD, which recovered by the end of the North American session initially sold off aggressively on the back of weaker Australian and Chinese manufacturing activity along with softer inflationary pressures. The turn in Chinese data and deterioration in domestic conditions puts the odds of a rate cut by the RBA next week at 50-50.

JPY: Yen Continues to Weaken on Disappointing Data

Once again, the Japanese Yen fell to fresh multiyear lows against all of the major currencies. Weaker than expected Japanese data contributed to the move lower but the improvement in risk appetite and lifted risk currencies.  We said that a further rally in USD/JPY would be caused by one of two potential factors - a less dovish Fed or a more dovish BoJ.  While we haven't heard much from central bank officials, the lack of consistent improvements in Japanese data will fuel speculation of additional easing by the new BoJ Governor, who takes office in April.  Last night, we learned that the unemployment rate in Japan increased in the month of December to 4.2% from 4.1%.  Overall household spending also dropped 0.7% year over year, which was the second largest decline in 11 months. Growth in housing starts also slowed to 10% from 10.3%.  The front of the week is light in terms of Japanese data but on Thursday evening, current account and trade numbers are scheduled for release.  Economists expect the export sector to be helped by a weak Yen but it will be interesting to see how much of impact Japan's territorial dispute with China continues to have on trade activity.