Strong USD rally could be on the horizon

US stocks continue to grind higher despite the IMF warning of low inflation, with traders now firmly positioned for a strong non-farm payrolls report on Friday.

Focusing solely on the US, it seems there is still strong interest to be long on equities and it’s not just the VIX which highlights the lack of macro concern. We’ve seen a strong taper in the Dow Transport sector, the Russell (small cap index) has also outperformed the S&P 500, while ETF’s have been more heavily sought than cash products – all sure signs of confidence.

Technically the S&P 500 is in blue-sky territory, however the rising wedge drawn from 2012 suggests the index could struggle at the top trend line at 1913. Still, any shorts from here seem fairly aggressive and would be fighting a strong trend. Today’s US services ISM  report is expected to show reasonable improvement (with the index moving from 51.6 to 53.5) and given the ADP payrolls report, a strong improvement in the employment sub-component should solidify already lofty expectations for Friday’s payrolls report.

Market pricing in a strong non-farm payrolls report on Friday

Judging by the selling in the long end of the US bond market it seems the market is positioned for around 220,000 jobs now, so once again the risk/reward trade favours short USD positions. However, I think this time could be different and feel we should get an upbeat number, in turn setting the stage for something more significant for the USD. Fed Chair Janet Yellen may have managed expectations earlier in the week, but we are getting more and more Fed officials giving fairly explicit time lines for a hike in the funds rate.

Dennis Lockhart (a centrist on the Fed board) yesterday suggested rates should go up in 2H 2015, with comments from John Williams (also a centrist) also providing a similar view today. The more hawkish James Bullard suggested rates could go up in Q1 2015. John Williams is not a voter on the board this year, but his views are a really good guide on fed policy as he is usually bang in the mid-point of the Fed hawkish/dovish divide.

Still, the fact that we are getting clear and increasing rhetoric on rates is of fundamental significance, and this firmly puts the USD in the mantra of a pro-cyclical currency. It also suggests the sensitivity the USD displays to key tier-one data will continue to increase over the coming months; hence the USD could be better bid (more so) against the JPY, CHF and also EUR on a good number. A break of the March 7 high of 2.81% on the US 10-year bond would also be a great help to the USD as well.

Asian markets have been generally bid today, with the ASX 200 the underperformer, while the Nikkei has put on 1.1% and CSI 300 up 0.7%, despite a slight slowdown in the pace of expansion in the official services PMI print.

AUD looking good against the JPY and NZD

The AUD looks good against the JPY and the NZD, with the latter a buy on dips to 1.0750 in my opinion. Today’s Australian data was fairly upbeat, with the February trade balance coming out above expectations at $1.2 billion, although this was offset by a modestly weaker-than-forecast retail sales report. The monthly read on retail sales increased 0.2%, however a few traders are pointing to the slowdown in the total seasonally adjusted print, which fell from 6.2% to 4.9%, although there’s a number of global economies who would love to see this sort of growth. AUD/USD looks a bit lost right now and I would not be surprised to see a bit of a move towards the 0.9150 area.

European markets are seeing modest upside, and the lack of any real directional trading bias from our Asia and European-based clients today (on our out-of hours markets) is testament to the view that markets of all description should see a holding pattern until after the ECB meeting. This is very much a ‘live’ meeting and if IMF head Christine Lagarde had her way then we could see the ECB react to the weak inflation data of late and cut its refinancing rate, taking into consideration that around 74 million Europeans are living under deflationary forces. It’s worth pointing out that Goldman Sachs is even calling for a 15 basis point cut to the deposit rate (i.e. effectively penalising banks for holding funds with them). If this comes to fruition then we could see the EUR head fairly quickly to 1.3500.

ECB Vice President Vitor Constancio seems to have shaped expectations, suggesting that there will be a recovery in inflation in April and that we are not likely to see not measures taking place. Certainly the improvement in credit and money supply and PMIs does suggest this could be true. However the issue is more around how dovish Mario Draghi sounds and, in theory, any rallies which prevail on the lack of any new easing measures from the ECB could see a sharp reversal if Mario Draghi shows strong concern that the risks to price stability have grown. It’s worth considering that money market rates (EONIA) rates have been fairly volatile of late and that’s another key measure the ECB look at.

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