Policy announcements from the European Central Bank (ECB) and Bank of Japan (BoJ) led to rallies in both EURUSD and USDJPY, but slow US non-farm payroll (NFP) data could quickly put those rallies in jeopardy.
When European Central Bank (ECB) President Mario Draghi initially spoke Thursday morning, his cautionary comments about the outlook for the Eurozone economy drove the EURUSD to a four-month low of 1.2746.However, during the Q&A session, the EURUSD began to recover and ended the day up approximately 0.7%.
While Draghi sounded more pessimistic than optimistic, saying there are downside risks in the second half, he also admitted that his hands are tied and the ECB's options are limited. Instead of giving any hints about the possibility for more easing outside of saying the discussions were "extensive" and the ECB stands ready to act if needed, he spent more time talking about what has been done so far and how it has benefitted the economy and stabilized the financial markets.
Draghi avoided giving a direct answer on additional easing, and investors interpreted this to mean that a rate cut won't come easy. He also argued that other players need to get involved, which suggested that he is relying on other governments and public agencies such as the European Investment Bank to provide additional stimulus by reviving SME (small- and medium-sized enterprise) financing.
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The EURUSD had been sold aggressively going into the monetary policy announcement on hopes that the ECB would ease, or at least lay the foundation for increasing stimulus. Unfortunately, Draghi failed to set the market up for a rate cut, and as a result, shorts were squeezed in.
Draghi also said the problems in Cyprus reinforced the central bank's determination to support the currency, and while he said Cyprus is "no template" for a future bailout, these comments suggest that the ECB will be quickly involved if another country were to face similar problems.
Is the EUR/USD Recovery Sustainable?
On a technical basis, the breakout in the EURUSD opens the door for a move to the currency pair's next resistance level of 1.30. A move to the 100-day simple moving average (SMA) at 1.3150 is also possible, but we are skeptical about the sustainability of this rally because another rate cut is still on the table.
While the ECB and Federal Reserve are both engaged in aggressive monetary easing, the ECB is discussing the need to increase stimulus, whereas the Fed is considering tapering off its asset purchases. This divergence in monetary policy plans should play a key role in the EURUSD outlook going forward.
We believe the main takeaway from Draghi's comments is that the ECB hasn't shut the door on additional easing. The concerns center on weak consumption and failed structural reforms, and while Eurozone growth should benefit from a recovery in global demand, so far, export demand is weak. We believe that the downside risks for the Eurozone are realistic and likely to increase in the coming months, especially if there is a correction in global equities.
FX Markets Counting Down to US Non-Farm Payrolls
The US non-farm payroll (NFP) report is scheduled for release on Friday, and the sustainability of the rallies in EURUSD and USDJPY will both hinge on the outcome of this key report. Economists are currently looking for job growth to increase by 190k in the month of March, down from 236k in February. Based on other labor market reports, the odds certainly favor weaker NFP numbers.
Challenger Grey & Christmas reported a 30% increase in layoffs in March and jobless claims jumped to 385k, though weekly claims were distorted by weather problems and the Easter holiday. Nonetheless, private payroll provider ADP said US companies added only 158K jobs last month, down from an upwardly revised 237K, and the employment component of non-manufacturing ISM dropped to a four-month low of 53.3 from 57.2.
Consumer confidence also declined last month, and all of these reports are consistent with slower job growth. The only wrinkle was jobless claims: Thursday’s number may have been bad, but the four-week moving average is still lower in March than in February.
If non-farm payrolls grow by 175K or less, USDJPY could slip more than 0.5%. In this case, the EURUSD will rally initially, but whether the rally lasts will depend on how bad the number is and its implications for risk.
Stronger payrolls, on the other hand, will fuel an additional rally in USDJPY that should take the pair up to its March high of 96.70.
USD/JPY Sets Sights on 100 Level
The biggest moves in the FX market Thursday were in the Japanese yen crosses, with USDJPY up more than 3.5% after the Bank of Japan (BoJ) easing measures satisfied investors. The BoJ expanded its Japanese government bond (JGB) purchases to 40-year bonds, which means that all JGB maturities are now eligible for purchase.
They also increased their target purchases to an annual pace of JPY 60-70 trillion, translating to about JPY 7 trillion a month, up from a prior level of JPY 3.7 trillion. This near doubling of monthly asset purchases represented bold action from the central bank. As expected, the BoJ merged its asset-purchase program with Rinban operations and abolished the banknote rule.
With this comprehensively aggressive easing, the correction in USDJPY is over. The currency pair is now trading above 95 and should be on its way 100. These latest policy moves signal that the BoJ is extremely serious about reaching its 2% inflation goal over the next two years, and BoJ Governor Haruhiko Kuroda even hopes to achieve it sooner. Therefore, even an abysmal non-farm payrolls report may not pose a lasting threat to the renewed uptrend in USDJPY.
The Key Catalyst for the British Pound (GBP)
The British pound (GBP) strengthened against the US dollar following better-than-expected service sector data. PMI services increased to 52.4 from 51.8 in the month of March, rounding out a set of PMI reports that have all signaled improved economic activity.
Earlier this week, we learned that construction activity improved with the contraction moderating, and while manufacturing activity fell short of expectations, it was still stronger than the previous month. The UK economy may not be performing as poorly as some economists fear, and this renewed optimism was enough to drive sterling higher.
As expected, the Bank of England (BoE) left monetary policy unchanged. We still believe that when the BoE meeting minutes are released, there will be continued caution within the central bank, but with the pound still trading near a three-year low, the upside pressure on inflation will remain a concern.
Halifax housing prices are the only UK data on the economic calendar Friday, but the US non-farm payrolls report will be the main driver of GBP flows for the day.
Crucial Job Data Outside of US Non-Farm Payrolls
It was a mixed day for commodity currencies as the Canadian (CAD) and New Zealand (NZD) dollars strengthened, but the Australian dollar (AUD) weakened. Friday will be a busy one for the CAD, with trade, employment, and manufacturing sector reports all scheduled for release. Typically, these are spaced out better, but the Easter holiday shifted the release date of some reports.
The CAD hit a one-month high in anticipation and could pare its gains if the data surprises to the downside. Of these three releases, the employment numbers should be the most market-moving. After adding 50k jobs last month, a far more modest 6.5k increase is expected. It is important to remember that Canadian employment will be released at the same time as US non-farm payrolls, and USDCAD will react based on the larger surprise.
Weak US job growth has traditionally been negative for the CAD, while stronger US growth is positive because of Canada's reliance on the US economy.
The AUD, on the other hand, initially rallied on the back of stronger data (service sector activity, retail sales, and building approvals all surprised to the upside), but gave up its gains after the BoJ announcement.
By Kathy Lien of BK Asset Management
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