The U.S. dollar extends gains after the Automatic Data Processing (ADP) report on private payrolls showed an unexpectedly strong 189,000 increase in November, following expectations of a 50,000 increase. The October ADP figure was revised to 119,000 from 106,000. Considering the improved track record of the ADP report in predicting the direction of the non-farm payroll (NFP) survey, we tentatively raise our forecast for Friday’s NFP to 110,000 from the initial 80,000. As is the case in the NFP, the extent to which the private payrolls created are durable (high-quality jobs) has yet to explored.
We are not yet issuing our final forecast until the release of this morning’s services ISM, which will provide an idea on services employment.
The 10 am release of the November services ISM is expected to show a modest retreat to 55 from 55.8. All eyes will be on the employment sub-index, which fell to 51.8 in October from 52.7 in September and 47.9 in August.
While the rallies on the stronger than expected ADP, will equities display a similar cheer, considering the probability that the Fed may not delver an aggressive rate cut in light of a strong payrolls report (above 100,000).
Fundamentals catch up with struggling sterling
Today’s downfall in British pound is being accelerated by the stronger than expected ADP report from the United States. UK economic data are moving from bad to worse and odds of a Bank of England rate cut tomorrow are nearing 50%. The HBOS/Halifax house price index fell 1.1% in November after a decline of 0.7% and 0.5% in October and September respectively, the first three-month decline in more than 12 years. The 1.1% decline was the steepest since last December.
Meanwhile, the Chartered Institute of Purchasing and Supply for the services sector tumbled unexpectedly to a 4 1/2 year low of 51.9 in November from October’s 53.1. Consensus forecasts were for a modest slip to 53.0.
UK’s 2.1% inflation, standing above the mandated target of 2.0% is the main obstacle to a central bank rate cut tomorrow. But since the Bank of England (BoE) already stated it based its latest inflation report on expectations of a Q1 2008 rate cut, there would be no real danger to inflation if it moved this week. From a cost-benefit analysis, the advantages of cutting rates tomorrow versus the perceived risks of overshooting rising inflation are greater than risking to wait until mid January, when the already accelerating momentum in financial market erosion may reach to emergency measures in January, prompting the BoE to make a 50-bps rate cut. The central bank is already under scrutiny/criticism for not doing enough regarding the Northern Rock failure, and for its slow reaction in providing liquidity in a faulty environment. With the last two weeks of the year risking to further fuel inter-bank rates and the economic data accelerating to the downside, the MPC may get the upper hand.
The other reason why the BoE should consider cutting rates is the interest rate differential relative to the United States and the euro zone. With the Fed expected to lower rates to at least 4.25%, leaving UK rates unchanged would lift the UK rate differential to a 2 1/2 year high of 1.50%, thus stoking further gains into the pound. In order to avoid the risk of acting too little too late in January, the BoE will have to cut rates by a quarter point. Our expectations of such outcome stand at 60%.
Cable dips to six-week lows at $2.0320, now eyeing the $2.03 support, which is likely to give way to $2.0270. Cable is known for its tendency to breach the figures (00) and find stability at the 60-70s. Combining the role of renewed reduction in risk appetite (dollar-weighted put/call ratio rose to extreme levels yesterday) and deteriorating UK fundamentals, the pair may encounter further erosion ahead. Upside capped at 2.0420.
Aussie accelerates losses, 0.86 in sight
Aussie extends losses to a 90 pips (nearly a full cent) from yesterday’s charts strategy where we pointed out the bearish reversal signal as seen though the head-and-shoulder formation. Last night’s fundamental catalyst to the latest price erosion was the Australia’s Q3 GDP report coming in within expectations at 1.0% q/q, but the y/y rate was at 4.3%, below expectations of 4.8%. Losses in the Aussie started on late Monday when retail sales rose 0.2% in October from September’s 0.7% increase, undershooting estimates of a 0.6% increase. Again, as in the case of sterling, Aussie faces further erosion by virtue of being a high yielding currency vulnerable to escalating bearishness in equity and by its weakening macro fundamentals.
Nearing the 0.8650 interim support, the pair is seen extending weakness towards the neckline support at 0.8620. Key foundation stands at 0.8540. Upside risk seen limited at 0.8720, followed by 0.8740. Considering the downward trend line resistance from the Nov 29 high, the bear remains intact at 0.8770.
Considering these developments, we expect further Aussie weakness against EUR and CHF.
Euro breaks below 1.47 after ADP
The stronger than expected ADP report on private payrolls is dragging the pair down to 1.47, as the report suggests a strong non-farm payrolls, which could support the dollar-rebound story and forecasts of falling gold prices. EUR/USD may sustain further downside at tomorrow’s press conference from European Central Bank’s (ECB) J.C. Trichet in the event that he focuses on the downside risks to the euro zone economy. Although rising inflationary pressures have been the main foundation to the euro’s resilience versus most currencies, the ECB may temper its hawkishness especially now that oil prices have receded.
EUR/USD sees interim support at 1.4630, followed by 1.46. Upside capped at 1.4730. Risks of further gains seen driven by downside surprise in services ISM.
USD/JPY gains capped at 111.20
The overnight rebound to 110.60 from 110 proved short-lived as the pair drops back towards 110. Given today's ADP strength, 110.80 presents interim resistance, followed by 111.20.
Separately, the extent of market weakness has reached a level when markets are grappling for a 50-basis point rate cut from a U.S. central bank that just one week ago indicated no need for change in policy rates. In the event that the Fed cuts Fed funds rate by 50-bps and the discount rate by the same amount, then we could see limited losses in the Japanese currency. Upside limited at 110.50, followed by 110.75. Support stands at 110, with chances of a breach of the figure calling up 109.80.
Ashraf Laidi
Chief FX Analyst
CMC Markets US
a.laidi@cmcmarkets.com
