U.S. Non-Farm Payroll (NFP) dominates this week’s sentiment
The U.S. Dollar remains on the lower side since the latest Federal Open Market Committee (FOMC) meeting when the Federal Reserve (Fed) refrained from reducing any asset purchasing. Last week, European currencies slightly outperformed the Greenback, but commodity currencies traded lower. All in all, the Greenback tended to be flat since there is no clear signal so far regarding the Fed’s policy in the upcoming few months.
It’s a heavy week amid global central bank meetings and some top-tier data from the U.S. The U.S. employment report will be paramount; the market is set to swing according to the release. I do see some uncertainties on the possible downward revision of the August report. If this is the case, the possibility of tapering in October looks extremely low when upcoming payrolls data will likely stay below 200K, despite possible jobs creation increasing, since it will certainly not reach the Fed’s expectation level.
Frankly speaking, there isn’t an available clue yet on tapering timing since the Fed highlighted many times that a change in asset purchases is not a preset course. Taking the labor market as an example, the change of payrolls is not consistent with the falling unemployment rate. A 35-year low labor market participation rate suggests that an increasing amount of people left the labor force. Besides the labor market, it looks difficult for inflation to inverse the downtrend which lasted for a prolonged period, since its Personal Consumption Expenditures (PCE) stands at 1.3% on a YoY basis.
The U.S. government also faces the risk of shutdown if Republican and Democrats can’t reach an agreement. Besides that, given the fact that Janet Yellen will succeed Ben Bernanke in the beginning of next year, the Fed will likely keep its dovish tone by strengthening its forward guildance and its dual mandate.
The Dollar faces challenges in resuming its bullish mode from earlier in the year amid rising uncertainties in the U.S. economy. Some analysts said that traders started pricing-in factors of a delayed tapering. I would rather call it a pricing-out of earlier high expectations of the U.S. economy and its financial condition. As long as the Treasuries yield curve keeps flattening, downside risk of the Greenback remains. Still, the payrolls data this week will offer some direction for various asset classes.
Global central bank watch
Various central banks will meet this week, including the Reserve Bank of Australia (RBA), Bank of England (BoE) and European Central Bank (ECB). Among these, the ECB could be the most attractive since investors are keen on further learning what the ECB monetary policy is, after Mario Draghi stressed that downside risks remain in the currency bloc. Besides that, I do not rule out the ECB starting to consider providing another tranche of long-term refinancing operations (LTRO).
For the RBA, I do not expect it to lower the Official Cash Rate (OCR) by another 25 bps since the central bank raised caution on excess lending. However, I still do not expect the RBA to excise similar guidance to the Reserve Bank of New Zealand (RBNZ). But the recent rising Aussie Dollar carries some substantial risk for the central bank to use verbal intervention, curbing further gain of the currency amid the economic recovery and positive sentiment on Shanghai’s Free-Trade Zone. Based on estimates, there will be another rate cut in November this year.
All attention will be on the ECB meeting. Mario Draghi shocked the market in its last meeting by introducing that the ECB is ready to act because the rising Eonia (Euro Over Night Index Average) rate may further dampen current deteriorating lending activities. If so, the recovery of the Euro Zone will not be sustainable. The higher Euro is another concern for the ECB, which will hurt the region’s exports. Based on these approaches, the upside of the Euro should be limited despite Technical indicators still suggesting that the EURUSD will swing higher.
Focus will be on language of the new LTRO, and I expect the ECB to inject further liquidity into its financial system by the end of the year and as early as this week. The Fed being dovish helps lower global borrowing costs but lifts the value of Dollar counterparts. Global central banks, except for the Fed, will not like this outcome, such as the ECB, BoJ, RBA, etc. Hence, it may accelerate the pace of birth for the new LTRO by the ECB, aiming to boost lending activities in the Euro Zone.
I think the LTRO may have limited impact on small and medium enterprise (SME) loans based on the previous few rounds. The main portion of the LTRO should continue serving large financial institutions for paying their obligations, but those liquidities will be limited for SMEs when their funding channels remain tight. Mario Draghi previously highlighted difficulties of introducing MBS due to its unpopularity in Europe. But I still do not expect the ECB to model BoE’s Funding for Lending Scheme (FLS) at this moment, since it doesn’t look feasible in the region.
Inflation becomes another forward guidance, and similar to the U.S., it was under deep pressure for a long period. Based on the subdued household consumption, inflation has no way to rebound sharply in upcoming months. The central bank may stress its worries on it and keep its overall statement further dovish.
Euro upside will be challenged
If all central banks excise loose monetary policy, major currencies will have another tug-of-war, like the “currency war” in the beginning of the year. But one thing is different: the Fed participates in this round and seems to have the most influential power compared to its “opponents.”
For the short term, I think the Euro may have some downside risks since the ECB will very likely carry on its dovish action or even “verbal intervention.” Regardless of any other “surprises” from the Fed (which depends on upcoming data), the ECB should have the capacity to bring rates and currency lower toward the end of the year.
The EURUSD should face some resistance on the level of 1.3680. As long as U.S. data could carry its current momentum or get better, the pair will likely correct to 1.31 and 1.30 toward the end of the year.
However, we will be cautious of the Fed’s direction besides the message from the ECB. The currency pair may surprise on the upside if the Fed tends to be further dovish.
Previous Market Brief of the Week: Market Brief of the Week for 23 September 2013: Let’s Be Fair – Quantitative Easing (QE) Uncertainties Reduce Economic Downside Risk