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An NFP Preview That's Due Out Wednesday

An NFP Preview That's Due Out Wednesday

2013-07-03 01:02:00
Kathy Lien, Technical Strategist
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With the USDJPY and EURUSD rallies hanging in the balance, Wednesday’s ISM non-manufacturing survey could provide valuable clues about Friday’s non-farm payrolls (NFP) report.

With essentially just one full-volume trading day to go before Friday’s pivotal US non-farm payrolls (NFP) report, the US dollar (USD) extended its gains against all major currencies on Tuesday. Milestones were reached in some pairs, while others broke key technical levels.

See also: 2 Important US Dollar Moves Happening Now

The sustainability of the dollar's rally has been nothing short of impressive, but it should not surprise investors since the strongest moves in the FX market are the ones supported by fundamental drivers. In this case, the Federal Reserve is getting ready to reduce the amount of monetary stimulus it provides, and investors are now just looking for economic data to confirm that the US economy is ready for tapering.

The dollar faces its first stern test on Wednesday, when a number of US reports are on the economic calendar to help shape expectations for Friday's release.

The most important of all the Wednesday reports will be the ISM non-manufacturing index. Earlier this week, we learned that the manufacturing sector lost jobs for the first time since 2009, and now, the question is whether the service sector suffered the same fate?

We don't think it did because, in that case, the Fed would not have lowered its unemployment rate forecasts, but there is always the risk of a downside surprise. Layoffs are expected to decline, and the ADP data will most likely report an increase in US payrolls as well.

For the US dollar to hold onto its gains, all that is needed is for these releases to meet expectations, but in order for USDJPY to break 101 and EURUSD to drop through 1.2950, an improvement needs to be seen in both the headline ISM non-manufacturing index and the employment component of that report.

If service sector activity slows, or worse, employment conditions contract, the dollar could quickly give up its gains as investors reset their expectations and reduce long dollar positions ahead of the non-farm payrolls report.

See also: The Primary Risk Facing USD/JPY

Last month, the employment component of this report dropped from 52 to 50.1, just a hair above the 50 line that defines expansionary and contractionary conditions. Therefore, a decline in this index would most likely mean job losses in the month of June, which would be unfavorable for the dollar.

Considering that many US investors and traders will be taking a long weekend starting around noon tomorrow, if the data misses expectations, we could see a heavy reversal of dollar long positions as investors square up for Thursday’s July 4 holiday.

Breakouts in 2 Major Yen Crosses

The weakness seen in the Japanese yen (JPY), and more specifically, the strength of the US dollar, drove both USDJPY and EURJPY above key levels. EURJPY was the first to gain momentum, taking out 130 and then 131 during the North American session. USDJPY broke 100 shortly after the New York open and extended to a high of 100.72 before settling slightly lower at the end of the day.

The 1.78% rally in the Nikkei overnight helped to keep both currency pairs bid throughout the day. Since dropping to a low of 12,445 on June 13, Japanese stocks have rebounded more than 13%.

USDJPY has a positive correlation with the Nikkei, and the recovery in Japanese equities has contributed to the currency pair's rise. The next level of resistance for USDJPY is at 102.50, a level the currency pair struggled to break in late May. For EURJPY, next resistance is at the June high of 131.40.

With no new Japanese economic reports on the calendar, the outlook for USDJPY and EURJPY will hinge on the performance of the Nikkei and Wednesday's US economic reports.

EUR/USD Breaks 1.30 on New Sovereign Debt Fears

The euro (EUR) was trading heavy throughout the Tuesday European and North American sessions, but it took the selloff in US stocks to drive the currency pair to its lowest level since June 3. The 1.30 level has finally been broken in a meaningful way, and we have to admit that we didn't expect it to happen on a day that was so light on economic data.

Nonetheless, investors are beginning to position for the strong possibility of dovish comments from the European Central Bank (ECB) on Thursday and a positive US NFP report on Friday.

Tuesday’s Eurozone economic data missed expectations, but the pressure out of Europe came primarily from German Chancellor Angela Merkel, who warned that the next aid payment to Greece could be delayed.

The Eurozone has given Greece three days to "deliver on the conditions attached to its international bailout" or risk not receiving the next tranche of aid. This warning goes hand-in-hand with a similar warning from the International Monetary Fund (IMF) last month, which builds an ominous case suggesting Europe's sovereign debt troubles are slowly returning.

A UK Data Surprise That’s Possible on Wednesday

Like many other major currencies, the British pound (GBP) weakened against the US dollar on Tuesday but strengthened against the euro. A survey by Markit revealed that UK construction rose for the second consecutive month to reach 51.0. The major contributor for growth was the residential building sector, where activity increased for five consecutive months thanks to the Funding for Lending Scheme (FLS).

The UK PMI services index is scheduled for release on Wednesday, and while economists are looking for slower growth, we feel there is scope for an upward surprise given the increase in manufacturing activity and improvement in consumer confidence last month.

The Lone Factor Supporting Commodity Dollars

Broad-based US dollar strength and dovish comments from the Reserve Bank of Australia (RBA) drove the Australian (AUD), New Zealand (NZD), and Canadian dollar (CAD) sharply lower against the greenback.

In light of slower Chinese growth, the RBA clearly does not want to risk reversing the downtrend in the AUD and threatening a key support for the economy. If tonight's Aussie economic reports show slower retail sales and service activity growth and/or a trade deficit, the AUDUSD could extend its slide below 91 cents.

If the data shows that the recent weakness in the AUD lifted growth, then the deeply sold currency pair could enjoy a relief rally.

See related: A Major Currency That’s Finally Bottomed

The USDCAD dropped to a one-year low, but losses would probably have been steeper if not for the rise in oil prices, which are now within striking distance of $100. Canada has trade numbers scheduled for release on Wednesday, but this report could take a backseat to US data and oil prices.

By Kathy Lien of BK Asset Management

DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.

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