Dollar and Yields Soar after Payrolls

The U.S. dollar ripped higher against all of the major currencies after the non-farm payrolls confirmed that the Federal Reserve is on track to taper asset purchases this year. Going into this key release, investors were looking for confirmation that the economy could handle a reduction in stimulus and they also wanted evidence that the labor market is improving like the Fed predicts. While the unemployment rate held steady at 7.6%, stronger than expected job growth and upward revision to the May report gave everyone the confidence that the jobless rate will slowly decline and meet the central bank's lowered expectations.

Non-farm payrolls hit 195K in June, the same amount as the previous month but only after a 20K upward revision. While economists were looking for a drop in the unemployment rate, the addition of more than 200K private sector jobs and increase in average hourly earnings was enough to send the dollar and U.S. bond yields sharply higher. The 10-year Treasury yield jumped 10bp from 2.56% to 2.66%, reaching its highest level since August 2011. USD/JPY broke 101, the GBP/USD dropped below 1.49 and the EUR/USD made its way towards 1.28. Compared to many of the other major currencies, the sell-off in EUR/USD has been modest so far but it should only be a matter of time before the currency pair catches up with its peers. Sterling has been hit the hardest and is extending a sell-off that has taken the currency pair down more 2.5% or 400 pips in the last 48 hours.

We believe that latest non-farm payrolls report will prompt the Federal Reserve to taper asset purchases in September. There is only two real opportunities for them to do so this year - September and December. This is such a major monetary policy shift that Fed Chairman Ben Bernanke will want to clarify the central bank's position and press conferences are scheduled after both of those meetings. If the Fed believed that the economy could handle it, they would much rather taper for the first time in September than December because the December meeting is too close to the holidays.

With labor market numbers confirming that the U.S. economy is performing well enough for the central bank to reduce stimulus, we expect a further rally in the dollar. As U.S. yields head towards 3%, we should not only see more investors cut their dollar funded carry trades but Japanese companies hedging against a rising yen (by selling dollars) will soon find those hedges too expensive to bear. We are also seeing more investors buy dollars outright and all of these factors should help to drive the EUR/USD below 1.28, USD/JPY to 103 and the GBP/USD below 1.48.