Realistically, today’s Employment Situation report will be the final piece in the jigsaw that will fulfill expectations of a rate hike by the Federal Reserve on 16th December. Janet Yellen painted a hawkish picture in a speech on Wednesday in which she said that the Fed move was still data dependent. The US dollar had a bad day yesterday in the wake of the failure of the European Central Bank to meet expectations on the extension of its quantitative easing program. However, the dollar bulls may have taken a knock, but they are still the dominant force in the market. Today’s Non-farm Payrolls report should ensure that the dollar strength resumes.
Having rallied by over 7% since mid-October, the US Dollar Index fell sharply yesterday, retracing almost half of those gains in one day with a drop of almost 3%. The decline was as reaction to the news that the European Central Bank failed to meet the lofty expectations of the market with regards to expanding its asset purchase program. With a massive short squeeze on the euro, the dollar was hit from all angles as forex and commodity prices rallied.
However, if you just park the euro to one side for a moment, the outlook of the other main currency pairs, Sterling/Dollar and Dollar/Yen show the bullish US dollar positions still in play. Cable remains in a strong downtrend and has simply rallied into resistance, whilst Dollar/Yen continues to consolidate strong gains over the past few weeks. These pairs simply look to have unwound and look to be open for another chance to sell amidst renewed dollar strength. There have been similar moves on commodities too with both gold and silver bouncing to simply look to renew downside potential.
The market has been busy pricing in a December rate hike by the Federal Reserve for a while now. Clearly yesterday’s move has been driven by the actions of another central banks, the ECB. The sharp weakening of the dollar is beneficial for the US economy and in effect allows the Fed more room to tighten as there is less concern over the dollar strength.
The dollar has been choppy this week as economic data has been mixed (to say the least, with both ISM Manufacturing and Non-Manufacturing significantly disappointing). However, Janet Yellen painted a fairly hawkish picture on Wednesday and despite her insisting (as ever) that the FOMC decision will remains data dependent. If we see the final Non-farm Payrolls prior to the FOMC meeting coming in with a solid report, then the market will certainly get back on-board with the tightening expectations.
What would a solid payrolls report look like? Well, consensus expectations has the headline at 200,000, unemployment at 5.0% and average hourly earnings of +0.2% month-on-month, so hitting those expectations would certainly be seen as solid and I would expect the dollar to react positively on that. After last month’s 271,000 jobs and improvement in average earnings growth it would probably need a headline number well below 150,000 (and downward revisions to prior months) and average earnings growth below 0.0% probably to get the market to ask serious questions of a rate hike now. I do not see this as happening.
Subsequently, when the volatility subsides today, I expect the dollar bulls to be the dominant force in the market still. This would involve Cable pulling lower to retest the $1.4895 low, Dollar/Yen testing above the 123.67 high and Gold back to new multi-year lows under $1045.85. As for the euro, well that is a difficult call as I believe that there will be continued volatility as large short positions continue to be unwound.