The dollar is little lower after the ADP estimate on private payrolls comes in at 97,000 for April from a revised 61,000, undershooting forecasts of 115,000 to 120,000. The report implies that April non-farm payrolls may come in weaker than the consensus forecasts of 140,000 to 150,000 in April after 88,000 in March. The ADP forecast of private payrolls has proven to have an increasingly effective track record in predicting the direction of non-farm payrolls. While today’s ADP report may prove dollar negative, it has the potential of helping U.S. equities counter some of the equity declines in Europe and Asia on the rationale that job weakness will deliver rate cuts from the Fed this year
The 6.5% overnight drop in China’s benchmark equity index may have been the most anticipated stock market sell-off of such magnitude in recent times, but a lesser-known prospect is the extent of a negative response from U.S. stocks today. Recall that one of the reasons causing U.S. equities to plunge by more than 3% in the infamous February 27 plunge, following the 9% drop in China, was a larger than expected drop in U.S. durable goods orders. European stocks are currently down by 0.9% to 1.0%.
The unwinding of FX carry trades resulting from the equity sell-off is limited to a decline in the high yielding Aussie and sterling, but is not triggering any notable gains in the yen. Consistent with our overnight piece “Loonie to still prevail on Aussie,” the Australian dollar is losing across the board, while the Canadian dollar continues to enjoy the gains from yesterday’s hawkish statement from the Bank of Canada.
The 2 pm EST release of the minutes of the May FOMC meeting will be important in shedding light on why the Fed neither acknowledges the worsening in the housing and labor markets, nor recognized the partial retreat in inflationary pressures. Markets may be at risk of a sharp pullback in the event that the minutes convey prolonged inflation preoccupation.
Euro shrugs ECB hawkishness, may be at risk of unwinding carry
The euro remains pressured against the dollar despite prolonged hawkishness from the European Central Bank hinting to a June rate hike. ECB Council member Garganas said price pressures are stronger than earlier forecasts and that interest rates have not yet peaked, indicating that market expectations for June are 'correct'. The Euro zone’s M3 rose 10.4% in the year ending in April while the three-month average rose to 10.4% from a revised 10.3%.
The euro has moved lower at times of unwinding carry trades and is doing so now, nearing the 1.34 figure. The combination of a strong ADP report and deteriorating sentiment in U.S. equities is likely to trigger the testing of the important 1.34 support level. The 1.3370 foundation is a more likely entry point for East European and Asian central banks as the territory represents a previous resistance.
Canadian dollar 30-year rally knows no limit The Canadian dollar drags its northern name sake to fresh 30-year lows at 1.0686, prolonging the gains following yesterday’s statement from the Bank of Canada (BoC) expressed concern with rising inflation, stating that "some increase in the target rate for the overnight rate may be required in the near term to bring inflation back to the target.” Regardless of whether the BoC will raise rates this summer, it has no choice but to preserve a hawkish stance, which will prove beneficial to its currency.
Our bullishness in the loonie remains intact, especially against the Australian dollar. AUD/CAD has fallen from 0.8790 in Asian trade to 0.8750, further nearing the 0.8715 target for week's end, which is the 11-month support.
USD/CAD is set up for further declines towards the 1.0650 and 1.0630. But we do warn that the pair is apt to turn around towards the 1.0770s and 1.08 in the event of a sharp sell-off in U.S. equities brought about by a sharp unwinding of carry traders and accompanied by gains in the Japanese currency.
Yen crucial in determining carry unwinding
The Japanese currency is not showing its usual pattern of strengthening. That is typical of global equity sell-offs, but this may change depending on the extent of selling in U.S. equities. Yen gains were limited to 121.37, before weakening to 121.61.
Despite widespread talk about the return of the carry trade, we stick with our reluctance to join the yen selling bandwagon, as the increasingly shaky foundation of world equity markets in technical terms raises the bar of out performance and the risk of sharp correction. This is seen in the topping out pattern of the S&P 500, DJIA and even the USD/JPY rate. U.S. data strength would deny this scenario in the short term, calling up 122.20, but we view mounting systemic risks from an equity market correction such as a resulting from further Chinese policy measures as reasons to wave the red flag on USD/JPY. Interim support stands at 121.20, followed by 120.80. An occurrence in the above fundamentals would also be detrimental to other high yielding pairs such as GBP/JPY and NZD/JPY. This would cause further declines in gold, until encountering our projected support of $635 per ounce.
Ashraf Laidi Chief FX Analyst CMC Markets US 140 Broadway, 30th Floor New York, NY 10005 (212) 644-4220 a.laidi@cmcmarkets.com
