Has Outlook for the Dollar Changed After Payrolls?

It has been a brutal week to be long U.S. dollars but Friday's non-farm payrolls report gave investors a glimmer of hope that the long dollar trade is still alive. Although job growth slowed materially in the month of January, the greenback traded higher against most of the major currencies on the back of a lower unemployment rate and higher wages. The Federal Reserve may be worried about global market volatility and low commodity prices but it will be difficult for them to ignore an unemployment rate below 5% and earnings growth at its strongest level in a year. Every part of today's labor market report outside of the absolute amount of job growth beat expectations including average weekly hours, manufacturing payrolls and labor force participation. Americans are working more and earning more, which is exactly what the Fed wants to see before interest rates are increased again.

BUT - investors shouldn't get ahead of themselves and buy dollars in droves because one piece of data is not enough for policymakers to pull the trigger. There's still about 6 more weeks to go before the next FOMC meeting and we'll get the opportunity to see whether the labor market maintained its strength in February. While the outlook for the dollar has brightened after today's jobs number, the next move for the dollar hinges upon Janet Yellen's testimony on the economy and monetary policy on Wednesday. If she shares Dudley's cautious outlook, the dollar will resume its slide but if she puts on a brave face and we think she will the dollar's recovery could gain traction. If we take a step back, all signs point to less Fed tightening this year but at the same time most economic reports show an outperformance of the U.S. economy which at the end of the day should make the dollar more attractive. The problem is that everyone piled into the long dollar trade and last week's wake up call from Dudley scared many investors out of their positions. In order for the dollar to regain strength, we would need an endorsement from Yellen in the form of continued optimism for the U.S. economy.

Meanwhile the U.S. was not the only country to release labor data today. This morning Canada reported a higher unemployment rate and net job losses. This deterioration contrasted sharply with the improvement in the U.S. economy, leading to sharp gains in USD/CAD. With more than 5k jobs lost last month, the unemployment rate hit its highest level 2 years. Low oil prices hit Canada's economy hard and in Alberta, the main oil producing region, the jobless rate reached its highest since 1996. Today's weak labor data completely overshadowed the significant improvement in the trade balance and the sharp rise in manufacturing activity. Thanks to a weaker Canadian dollar, exports of autos surged, helping to drive the IVEY PMI index to its strongest level in nearly 4 years. The Bank of Canada is right in thinking that the non-resource economy will pick up the slack for resources but given how quickly and aggressively oil prices have fallen, we're skeptical about how much offset there can be in the near term.

The commodity currencies were the biggest movers with the Australian and New Zealand dollars falling more than 1.5% against the greenback. AUD was the day's worst performer with softer retail sales and PMI numbers adding pressure on the currency. Last night we learned that the construction sector contracted at its fastest pace since February 2015 and that consumer spending stagnated. This was significantly weaker than the market's forecast for steady 0.4% growth at the end of the year. The Reserve Bank also released its monetary policy statement in which they said there's scope for further easing. However even with their concerns about China's economy, their view that employment growth is strong enough to support a reduction in the jobless rate and their positive outlook on the service sector suggests that they are in no rush to ease. With no economic reports released from New Zealand, the weakness of NZD can be attributed to 3 things - U.S. dollar strength, profit taking and lower commodity prices.

After rising for 4 straight trading days, the euro retraced against the U.S. dollar on Friday. Unlike many other major currencies, the limited pullback in EUR/USD kept the currency pair above key resistance. EUR/USD broke out of a 7 week long consolidation below 1.1050 and is now still trading above this level. German factory orders fell more than expected pointing to a softer industrial production report on Monday. However something more important than IP (maybe Yellen's speech) will be needed to push EUR/USD back into the 1.08 to 1.1050 trading range.

The rally in sterling on the other hand stopped short of the 50-day SMA this week so a deeper correction could still be possible before Yellen's testimony. Part of the currency's weakness had to do with the fact that Brexit is back in the headlines. According to the latest polls, 45% of respondents favor leaving the EU while only 36% wanted to stay. Our colleague Boris Schlossberg wrote this morning that "The near 10% gap is a troubling sign especially given the generally positive rhetoric coming out of Brussels on the latest round of negotiations. With nearly 20% of the vote undecided the market hopes are that the stay vote will eventually prevail, but the danger of Brexit remains very real and could cause havoc not only GBP/USD trade but in EUR/USD trade as well as it could open the way for general EU fracture."