The legacy of a disappointing US payrolls report still dragging on sentiment

Macro Outlook

“There was a discussion on QE, it wasn’t neglected”. This is what said Mario Draghi at this month’s ECB press conference. So, has Draghi finally fired the starting gun on Euro weakness? This is a marked change from March’s ECB rhetoric where Draghi was defiant that inflation was bottoming, now he and the policy setting council are increasingly concerned that inflation may be prolonged at low levels. With central banks on obviously divergent paths, selling the Euro should be the easiest trade in the world, but despite the consensus strongly Euro negative against the Euro, yet with the ECB behind the curve Euro/Dollar has still stubbornly refused to go down. There are certain barriers to easier monetary policy, the ECB may wish to wait until the bank stress test results later in the year before it can contemplate negative deposit rates, while questions over the legality of QE and the direct financing of governments could also hamper efforts. However, the fact that QE is now firmly on the table as an option should now draw a line at $1.4000 for the Euro. Selling rallies on the Euro has been the sensible trade for a while, you never know it might even now be the right one too.

Must watch out for: Bank of Japan Monetary Policy

Impact: The yen has weakened significantly in the past week as the government’s implementation of the hike in sales tax from 5% to 8% has been brought in. The last time this happened Japan fell into recession and the expectations is that the Bank of Japan will need to ease monetary policy further to prevent this from happening again. The inflation rise has recently stalled but this month may be a little early for further QE as the BoJ may want to first see the impact of the tax rise. The weaker yen will be welcomed and the BoJ is likely to sit on it hands for at least another month.

Foreign Exchange

Forex traders struggled what to make of the Non-farm Payrolls report on Friday. Adding 192,000 jobs in March was slightly lower than the revised 197,000 in February and also under the 200,000 expected by the market. However, the participation rate improved to 63.2% from 63.0% as more Americans entered the labor force. On the balance a reasonable report then has created a quandary for those sitting on dollar profits built up over the past few days as the greenback has made gains against the Euro, Sterling and the Yen alike. Fundamentally, the payrolls report could have been stronger, but gives little reason for the Fed to deviate from its chosen path. This should mean a continuation expectation of dollar outperformance by the market. However, with little US economic announcements this week, perhaps there is an excuse for some profit taking after all.

WATCH FOR: Following the recent gains in Dollar/Yen key focus will come on Tuesday’s Bank of Japan monetary policy. The FOMC minutes will provide a little more meat on the bones to Janet Yellen’s press conference and could impact the dollar. Risk appetite will be impacted on Thursday with Chinese trade balance and also Aussie unemployment, while Chinese inflation on Friday will also be watched.

Indices

Investors will get a look at Q2 corporate performance as earnings season in the US kicks off in earnest on Tuesday with Alcoa. After a fairly mixed earnings season in Q1, this could be a very important for the market which is still struggling to ascertain the real impact of the bleak winter in the States. As ever, estimates have been driven down to help ensure positive earnings surprises, however projected earnings of around 5% for the quarter is expected. Whether this is enough to justify the S&P once more up at all time highs and trading on around 15.5x prospective earnings is another matter. Turning to European indices, to get a gauge of the scale of the under performance of the FTSE 100 versus the DAX, we need to just consider the respective recoveries from the March lows. Last Thursday, the FTSE 100 successfully breached the 50% Fibonacci retracement of the 6866 to 6493 March sell-off at 6679. The DAX however, achieved a similar landmark over two weeks ago and on Friday achieved a100% retracement of its equivalent decline.

WATCH FOR: US earnings season will start to drive the S&P with Alcoa kicking off after hours on Tuesday. Risk appetite could also get a steer from the Japanese monetary policy on Tuesday, in addition to Chinese trade balance on Thursday. China inflation on Friday may also indicate whether the People’s Bank of China will be able to ease the reserve requirement ratio and benefit risk appetite further in the region.

Commodities

The rally for gold on Friday after Non-farm Payrolls was an interesting move as it came amidst a flight to safety with yen and Swiss franc strength, and Euro and Sterling weakness. Reports of violent protests in eastern Ukraine over the weekend suggests that geopolitics in the region could still boil over once more which could be supportive for precious metals such as gold and silver. Dollar strength remains a driver of weakness in the gold and silver prices, so anything that may result in a reversal of this strength could help to boost the precious metals. This week’s Fed meeting minutes should give more detail of the Fed’s views and to how much weight investors give Janet Yellen’s infamous “six months” between the end of tapering and possible tightening. Brent crude is under pressure once more amid reports that there has been an agreement between Libyan officials and rebels that could see the re-opening of two oil ports that would more than double Libya’s oil capacity.

WATCH FOR: Interest in gold and silver as an insurance trade could increase once more if social tensions in eastern Ukraine elevate this week. The Fed meeting minutes on Wednesday could impact on dollar strength and subsequently have an inverse impact on precious metals. The China data out this week could impact on oil, if the trade balance and inflation continue to suggest a slowing of growth.