The Dollar Could Correct Further After Muted Jobs Report

With less than 2 weeks to go before the December Federal Reserve meeting, investors were not impressed by the latest U.S. jobs report. They were happy to see job growth rise by 178K, but the increase was less than 200K and accompanied by a drop in average hourly earnings.  The fall in wages was surprising and probably the weakest component of the report.  The Fed will still raise interest rates later this month because the unemployment rate is down to 4.6%, its lowest level since 2006.  However the chance of an early 2017 follow-up hike faded with the subdued non-farm payrolls report. While the dollar did not fall by much, ten year Treasury yields dropped nearly 6bp, signaling the possibility of additional profit taking in the new week. Fed fund futures show a 100% chance of a hike this month but the odds of another quarter point move don't exceed 50% until June 2017. This means investors expect a hike followed by a long pause.  The U.S. dollar has had a great run but after Friday's data the uptrend is exhausting with the market fully discounting a 25bp rate hike.  As the rate decision nears, we could see more two way action in the currency.  There are no major U.S. economic reports scheduled for release next week.  The ISM non-manufacturing number is the most market moving piece of data on the calendar but its significance is lessened after the NFP release.  Instead, the focus should be on comments from Fed Presidents Dudley and Bullard and any potential guidance they may provide.

 

Next week's lighter U.S. calendar means it could be a week where currencies are more sensitive to developments in other parts of the world. In other words, it probably won't be a week where the dollar rises or falls against all of the major currencies.  The biggest "risk" for the market in the coming week will be Sunday's Italian referendum on Senate reform.  If you are not familiar with the changes, Italian voters have the opportunity to vote on reducing the role of the Senate and streamline decision-making.  If the "no" camp wins, we could see major turbulence in European financial markets and significant weakness in the euro because Prime Minister Renzi pledged to resign.  If he follows through, it would usher in a new period of political uncertainty that will make foreign investors less likely to fund and bailout Italian banks.  A no vote would create a crisis of confidence in Italy's financial sector and flight of capital out of the Eurozone's third largest economy. While some analysts argue that a no vote has already been priced in, we beg to differ and believe that some investors are holding out hope that saner minds will prevail and the Senate reform will be approved.  If it is, we could see a generous short squeeze in EUR/USD ahead of the European Central Bank meeting.  However if it is rejected, the new trading week should start off with a major sell-off in the euro, European stocks and Italian bonds. 

 

There are also 3 central bank meetings on the calendar including the European Central Bank's monetary policy announcement.  Even though some ECB sources say the central bank could ease, other sources suggest that it is too soon to make any changes to monetary policy.  This is confusing but all we need to do is pay attention to the recent comments from Mario Draghi who has taken every opportunity to highlight improvements in the economy - this tells us that he is less inclined to increase stimulus unless the financial markets are rocked by a no vote in Italy.

 

All three of the commodity currencies traded higher this past week but the big story was the Canadian dollar and the OPEC meeting. OPEC ministers finally announced a deal in Vienna to cut daily oil production by 1.2 million barrels, sending oil prices sharply higher. While some analysts had hoped for a 1.4 million reduction there was a good chance last night that there would be no deal so everyone was relieved when an agreement was reached. Non-OPEC nations were also asked to reduce production by 600K barrels a day with Iran given the special exemption to keep raising production. This concession reflects how desperate oil producing nations are to end the supply glut and reverse the downtrend in prices, which is less than 50% of 2014 lows.  The deal is still contingent on the participation on non-OPEC nations like Russia who has said they can only reduce production at a moderate pace.  Either way, we expect oil to continue moving higher in the coming days and USD/CAD to move lower. Canadian data was also better than expecting with GDP growth accelerating significantly in the third quarter and job growth continuing against expectations for a fall. Therefore the only thing preventing USD/CAD from crashing are U.S. yields but they are beginning to slip as well.

 

The Bank of Canada meets next week and while there's been a lot of volatility in oil prices, Canada continues to grow.  Recent comments from central bank governor Poloz suggests that it would take a lot for the BoC to consider lowering rates again because inflation has been on the rise and expected to return to target by mid 2017.  No changes are expected to monetary policy but the central bank's guidance is difficult to predict.  On data alone, the BoC should be a more optimistic but a Trump Presidency poses a major risk for Canada because of the President-elect plans to completely renegotiate NAFTA. The BoC could choose to table the issue for the time being and focus on current developments or they could incorporate the risk to their outlook.  We believe they'll opt to focus on the facts rather than the unknown and maintain an upbeat outlook that should be positive for CAD.

 

The Australian and New Zealand dollars traded primarily on anti-U.S. dollar flows.  There were a few pieces of Australian data released over the past week - manufacturing PMI and retail sales.  Both reports showed improvements from the previous month, helping to lift the Australian dollar. Chinese manufacturing PMI numbers were also better than expected.  It should be a busy week for the Australian dollar with third quarter GDP numbers and a Reserve Bank of Australia monetary policy meeting on the calendar.  The RBA has been optimistic and should remain so with Chinese economic reports stabilizing. No major economic reports were released from New Zealand but the Reserve Bank published its latest Financial Stability Report.  The RBNZ maintained a relatively positive tone but highlighted the risks to the financial sector.  The report did not have a significant impact on the currency although NZD has been performing much better than AUD. The Treasury publishes its monthly economic indicators in the coming week and the government releases its half year economic and fiscal update. Optimistic forecasts will help NZD but the currency has been quiet strong versus the Australian dollar so the central bank could be more cautious.