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EUR/USD has stabilised into the $1.1100 area today and has seen modest short covering after Mario Draghi laid the foundation for additional asset purchases. There has been a sceptical tone from clients, but if anyone is to be taken at their word it is Mario Draghi. What he has done, though, is allow traders to hold back on EUR purchases at a time when it is unclear if the Federal Reserve will tighten monetary policy.
$1.1230 becomes the new line in the sand for traders, as this is where EUR/USD fell from during the ECB press conference and, if we see a disappointing payrolls print, then this level could be tested.
Asian equities have been generally mixed today, with the Nikkei opening the day on a sour note. Poor labour cash earnings and summer bonus payments clearly haven’t helped sentiment, but the moves in Japanese equities seem to have triggered a stop loss run on S&P futures in turn, specifically when the price fell through yesterday’s session low of 1,942.
As things stand, US markets are facing a modest headwind. Importantly, S&P futures are 1.4% lower relative to where European markets closed; hence we expect weakness on the open. Mario Draghi may threaten the idea of additional asset purchases for a potentially longer duration, but sentiment can be a very powerful force when traders just don’t want to hold equities.
One of the other big talking points today has been the moves in AUD/USD, which has moved convincingly below $0.7000. It seems the whole world owns a short contract on the AUD at present, although I personally feel short AUD/CAD is an attractive alternative.
Negative positioning has got very stretched in AUD, but positioning alone is never going to give you the positive expectancy needed to be a profitable trader, especially when the trend is so powerful. All roads lead to a lower AUD and, as I have said many times, the Australian economy is the big unknown in the G10 currency region.
Of course, it’s now all down to the US labour market to set the tone for risk appetite going forward. You can throw in all the talk of portfolio adjustments from Risk Parity and CTA (commodity trading advisors) funds as increased volatility sees these massive funds dump assets into the market. There is talk implying much more of this remains to play out.
Looking at the playbook around the payrolls
Focusing on the payrolls event itself, we know interest rate markets are currently pricing in a 30% probability of a September hike in interest rates from the Federal Reserve, 42% for October and 57% for December. So tonight’s US non-farm payrolls report (22:30 AEST) provides an important piece of the economic jigsaw. With that sort of pricing we know that there are dislocations in assets.
What are the expectations?
The market consensus is that we’ll see 218,000 jobs created, with economists’ estimates ranging from 253,000 to 120,000. The unemployment rate is expected to tick down to 5.2%, moving into the Fed’s full employment target.
Average hourly earnings (yoy) are expected to increase a modest 2.1%. The U6 unemployment rate (the broadest measure of employment) fell to 10.4% in July – the lowest level since July 2008. This needs to be watched.
The traditional leading indicators suggest a robust jobs print tonight, with the August ADP private payrolls coming in at 190,000, while the employment sub-component index of the services ISM shows 56.0.
This is clearly the best result all round. On this result, US bond yields push aggressively higher, in turn putting a strong bid into the USD. Emerging-market assets will likely be sold aggressively (I specifically like long positions in AUD/BRL).
A point of contention is whether US equities would rally given that we should see the implied probability of a near-term increase in the fed funds rate.
My view is a 250,000+ print would provide increased clarity around Fed policy and this should prove to be a strong positive for US equities, although others will argue against this view.
I would also look at spikes in implied volatility. Being long volatility index futures would work well in this environment.
If 165,000 to 180,000 jobs are created
This is a grey area and the scenario I feel would actually prove to be the worst case for market participants. If you are an economist who has September or October pencilled in for Fed rate hikes then you probably wouldn’t amend that view, but the growth in job creation is lacklustre and would provide the least amount of clarity. I would personally expect a modest sell-off in the USD, with USD/JPY likely to push back into the ¥119.50 area.
US equities would not know where to turn, but I suspect traders would focus much more closely on the unemployment rate or hourly earnings and drill into the report for inspiration.
150,000 and under
Clearly the 30% probability already priced into the September meeting would be reversed and would mean strong buying in US treasuries across the curve. It would mean a much weaker USD and, given the extended nature of AUD short positions (held by leveraged funds), I would look for a move in AUD/USD into $0.7150 to $0.7200.
Emerging-market currencies would rally aggressively given how unloved they are at present. US equities would likely sell off, although again there are some who feel the opposite is true and we would get a stimulus-invoked rally. Given global growth has been a concern for investors and traders, I suspect these risks will resurface and US equities will be sold.
Keep in mind that August is traditionally a poor month of job creation relative to expectations. As Deutsche points out, August employment has missed consensus in 21 out of the last 27 years. More recently, the last four Augusts have missed consensus by a sizeable 55,000.
As they say, past behaviour doesn't predict future performance. However, if the seasonal weakness continues, I struggle to see how the Fed could move rates not only in September, but at any time in 2015.
Finally, bear in mind Richmond Fed member Jeffrey Lacker (voter) speaks 20 minutes before the jobs data. His speech is titled ‘the case against further delay’.