Dollar Pops then Drops after Payrolls, Here's Why

The U.S. economy lost 40k jobs in the month of September but instead of falling, the greenback enjoyed strong broad based gains this past week.  USD/JPY broke above 113 and hit its highest level in nearly 3 months. It gave up those gains on reports that North Korea could conduct a missile test this weekend but the fundamentals supporting the greenback have not changed.   Friday's NFP release capped off a very good week for the dollar, which rose more than 2.5% versus sterling and over 1% against the Swiss Franc, Australian and New Zealand dollars. The euro, Canadian dollar and Japanese Yen were the most resilient but they still experienced losses.  Looking ahead, the U.S. dollar should recapture its gains in the new trading week ahead of the U.S. retail sales report.

Stronger than expected economic data along with hawkish comments from Federal Reserve officials helped to propel the dollar sharply higher this past week before the rally fizzled.  Although investors were concerned about the impact of the hurricanes on job growth, the stronger manufacturing and non-manufacturing ISM reports set the dollar's course at the beginning of the week. So while the impact of the hurricanes on payrolls was more significant than economists anticipated (they were looking for 80K job growth but instead saw -33K job losses), investors quickly discounted the headline number and instead latched on to the upward revision in August, the strong 0.5% rise in average hourly earnings and the lowest unemployment rate since 2001.  While the dollar retreated from its highs on reports that North Korea could test missiles this weekend, there's no refuting the strength of Friday's jobs report. These better than expected numbers reinforce the Fed's hawkishness and helped drive up expectations for a year-end rate hike to 77% from 70% one week prior. Just like in 2005 after Hurricane Katrina, everyone is looking for payrolls to be revised higher and rebound next month.  With manufacturing and service sector activity accelerating and wage growth rising, we expect the dollar to extend its gains in the coming week. The FOMC minutes scheduled for release on Wednesday should be hawkish and with gas prices rising and wage growth increasing, economists are also looking for a very sharp recovery in retail sales that should take USD/JPY back to its highs near 113.50.  

Although the euro reversed its losses to end the last trading day of the week higher against the greenback, it was still a challenging one for the currency, which fell to its lowest level in 2 months.  Catalonia, which voted to split with Spain a week ago is no closer to making it official. Spanish courts are still trying to block the independence move and have suspended an important meeting of Catalonia's regional parliament on Monday. This was the Catalan President's first opportunity to formalize their declaration of independence under a referendum law that the Spanish Constitutional Courts have ruled as illegal. This back and forth will continue for sometime and while the outcome will have a significant near and possibly long term impact on the euro, for the time being investors have moved on.  The next big focus will be the European Central Bank's monetary policy announcement and the ECB is widely expected to recalibrate policy.  However the "minutes" from the last policy meeting did not reflect an overly hawkish central bank. They felt that even with a reduction in their Quantitative Easing program, substantial stimulus is still needed. They also expressed concerns about the volatility and speed of the euro's rise and agreed to monitor exchange rate moves carefully.  All of this suggests that while the central bank is committed to reducing bond purchases, they won't be raising interest rates anytime soon. This past week's Eurozone economic reports were mixed with retail sales falling but German factory orders rising. Germany's industrial production and trade balance reports are scheduled for release in the new week but the main focus will be on Thursday'sspeech by ECB President Draghi.  While we are bullish dollars, we also like euros ahead of ECB and can see the pair trade back up to 1.1850. 

The worst performing currency this past week was sterling which dropped through 4 big figures to lose over 2% of its value versus the U.S. dollar. It underperformed every major currency despite mixed UK data. The latest PMI reports showed a slightly slowdown in manufacturing activity, a contraction in construction sector activity and acceleration in service sector activity. Taken together, these reports do not undermine the Bank of England's hawkishness but concerns about Brexit and U.S. dollar strength still plague the currency.  Last week, Prime Minister May made a disastrous speech where she was a victim of a prank then fell into a coughing fit. While neither of these are serious offenses, the media and her opponents saw it as a reflection of her weak leadership. A number of Tory MPs want May to resign according to former minister Ed Vaizey.  Her political troubles have driven GBPUSD down to 1.3027 and with no major U.K economic reports on the calendar in the coming week investors will be watching the 1.30 level closely to see if it holds or breaks.  

Meanwhile the Canadian dollar refuses to fall. Even with this past week's rally, every sell-off as been met with buyers which is surprising considering the level of overstretched USD/CAD short positions and the Bank of Canada's less hawkish guidance.  It is clear that USD/CAD traders don't want to give up on their short trades even though many economists are dropping their calls for another rate hike this year.  USD/CAD rejected 1.26 on Friday after relatively healthy Canadian data. Although net job growth in Sept

was slightly less than anticipated (10K vs. 12K) and the participation rate fell slightly, full time jobs rose at its strongest pace on record.  Canada has now experienced its 10th straight month of employment gains and its fastest pace of wage gains in 17 months. Its too early to say if these numbers will change the BoC's minds especially after the larger trade deficit and decline in oil prices but it was clearly enough for USD/CAD traders to keep selling. There are no Canadian economic reports scheduled for release this coming week so loonie traders will be primarily watching Bank of Canada Deputy Governor Wilkins' speeches but its not clear whether she will touch on monetary policy.  Either way, USD/CAD is trading heavy and appears poised for a move back to 1.2450.

The Australian dollar also hit a 3 month low while the New Zealand dollar dropped to a 4 month low versus the greenback. Back to back weakness in Australian data along with a relatively benign Reserve Bank of Australia monetary policy announcement prevented AUD/USD from rallying all week. According to the latest reports, building approvals, manufacturing and service sector activity slowed. While the trade surplus increased, retail sales dropped by the largest amount since March 2013. This deterioration drove AUD/USD below the 200-day SMA near .7150, which is a key support level and puts the pair at risk of a deeper slide towards 70 cents this coming week.  There are no major Australian economic reports to support the currency so the only hope is China's trade balance.  Investors will be watching this report closely to see if exports recover as the World Bank's upgraded GDP forecasts suggest.  There were no major economic reports released from New Zealand but the currency fell on the back of U.S. dollar strength, lower dairy prices and ongoing election uncertainty.  The market's appetite for the U.S. dollar and the local election will remain the key drivers of the currency next week as there are also no major reports scheduled for release.  This weekend, the official election results along with each party's share of the votes will be announced and that should help minority leader Winston Peters decide who to form a new government with.  The incumbent Bill English won the most votes but the Labour party's Jacinda Arden refuses to back down.  We are not sure whether the results will provide much clarity but after 2 weeks of political uncertainty, Peters expects to make a decision by October 12th.