Will Payrolls Propel the Dollar to New Highs?

• Will Payrolls Propel the Dollar to New Highs?
• USD/CAD Hovers Below 1.25 Ahead of Canadian Employment Report
• AUD Hit by Record Trade Deficit
• NZD Falls in Sympathy
• EUR: Surprise, Surprise, Greek Talks are Getting Messy
• GBP - BoE Leaves Policy Unchanged
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Will Payrolls Propel the Dollar to New Highs?

With less than 24 hours to go before Friday's non-farm payrolls report, the U.S. dollar is holding up well.  The greenback traded higher versus the Japanese Yen, Canadian, Australian and New Zealand dollars. While it lost ground versus the British pound, it held steady against the euro and Swiss Franc.  The dollar has performed extremely well this month as investors reset their expectations for Fed tightening.  While everyone believes that the central bank will leave interest rates unchanged this month, investors are looking for hawkish comments and more direct guidance for a September rate hike from Janet Yellen in June.  Whether she satisfies the market depends in large part on tomorrow's labor market report. Non-farm payrolls is the next major catalyst for a break higher in the dollar. However the greenback is trading right below a key level versus the yen and an unambiguously strong payrolls report is needed to drive USD/JPY above 125. While most of the economic reports we track point to stronger job growth in the month of May, the most important release - non-manufacturing ISM showed a slowdown in labor market activity.  Nonetheless the employment index still printed at 55, representing expansionary conditions.  So in a nutshell while a good non-farm payrolls report is likely it is not a done deal but a firm report will drive USD/JPY swiftly above 125.  To hold the move however, we would need to see a steady or lower unemployment rate and most importantly, an increase in average hourly earnings.  In fact, earnings is more important than the absolute amount of job growth these days since payrolls have been hovering around 200k for the past year give or take a few outlier reports like the March release. There's no doubt that the U.S. economy and the labor market is improving but the dollar is also overbought so even if it pushes higher on the back of a strong jobs number, it could be hit by profit taking next week as investors cut back on some of their positions ahead of the June 17th FOMC rate decision.  In the meantime, take a look at how the leading indicators for the May non-farm payrolls report stacks up: 

How the May Leading Indicators for NFP Stack Up 

Arguments for Stronger Payrolls 

1.     Challenger Job Cuts Drop 22.5%, First Drop Since November
2.     Continuing Claims Falls to Lowest Level in 15 years
3.     ADP Employment Index Rises to 201K from 169K
4.     Rise in Employment Component of ISM Manufacturing Index
5.     Rise in Consumer Confidence 

Arguments for Weaker Payrolls 

1.     Drop in Employment Component of ISM Non-Manufacturing Index
2.     Steep Decline in University of Michigan Consumer Sentiment Index
3.     4 Week Moving Average of Jobless Claims Rises to 274K from 271K, Rebound Off 15 Year Low 

USD/CAD Hovers Below 1.25 Ahead of Canadian Employment Report 

Canada also has an employment report scheduled for release on Friday and like the U.S., stronger job growth is expected. After losing close to 20k jobs in April, a rebound of 10k is expected but an increase would only be positive for the Canadian dollar if part of the job was full time and unfortunately that is not what economists anticipate.  Yet we cannot rule out an upside surprise in the report because according to today's IVEY PMI report, manufacturing activity expanded at its fastest pace in 2 years. The index jumped to 62.3 from 58.2 when the forecast was for a drop to 55. So as you can see, economists are more pessimistic on Canada's economy than the data necessitates.  The employment component of the report also ticked higher, confirming that the odds favor a stronger Canadian employment report.  If both the U.S. and Canadian reports surprise to the upside, the currency pair to trade will be CAD/JPY as it has been itching to close above 100.  Meanwhile the biggest mover today was the Australian dollar, which lost more than 1% of its value against the greenback. The currency was hit hard by a larger than expected trade deficit and flat consumer spending.  Economists had been looking for stronger retail sales but as signaled by the retail subcomponent of PMI services, spending weakened in the month of April.  The trade deficit also hit its highest level ever with exports falling 6%. While part of this was due to severe weather temporarily shutting down ports, the decline will still negatively affect Q2 GDP growth.  AUD/USD now looks poised for a test and possibly even a break of 76 cents.  With no major economic reports released today, the New Zealand dollar fell in sympathy with AUD. 

EUR: Surprise, Surprise, Greek Talks are Getting Messy 

Euro ended the day slightly higher versus the U.S. dollar, which is a bit surprising because the Greek debt talks are getting messy. Of course that should not be unexpected because we've been down this road many times before. In the latest chapter of the Greek saga, Tsipras said the government will not accept extreme proposals and that "our proposal continues to be the only realistic and constructive proposal." In other words, they are not happy with the plan drawn up by the EU and IMF which means that once again the negotiations could come down to the wire. Greece has also told the IMF that they will not be able to make this week's 321 million euro payment and have asked to bundle it into one 1.5 billion euro payment at the end of the month. Clearly they are banking on the release of fresh bailout funds before the June 30th deadline.  While we firmly believe that some type of agreement will be made before the end of the month, there could be more painful discussions in the weeks that follow. The outlook for the EUR/USD this month is tricky because of the big event risks for the dollar and euro.  In the near term, non-farm payrolls will have the biggest impact on the pair. Then next week, it will be all about Greece and US retail sales followed by the FOMC rate decision the week after and then the Greek bailout deadline.   

GBP - BoE Leaves Policy Unchanged

The British pound ended the day higher against the U.S. dollar after the Bank of England left monetary policy unchanged. We are a bit surprised by the strength of sterling because house prices fell 0.1% but with 10 year Treasury yields falling by a larger amount than Gilt yields of the same maturity, the rebound in the currency pair is not unusual.  As mentioned in yesterday's note, we believe that UK policymakers are on the fence about raising interest rates this year because the increase in the manufacturing and construction sector PMI indices was offset by declines in PMI services and composite. Activity in the largest part of the UK economy fell by the sharpest amount in 4 years. So the case for a rate hike has weakened and when the minutes are released from tomorrow's meeting 2 weeks later, they will most likely show a cautious central bank that intends to keep policy unchanged for the rest of the year.