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Daily Commentary 06/03/15

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Monetary policy divergence, not economics, powering USD higher The dollar was generally higher against most G10 currencies despite disappointing data. The key reason is probably the monetary divergence between the US and Europe in the first place but most other countries as well, which was emphasized yesterday by ECB President Draghi’s explanation of the details of Europe’s QE program.

Draghi initially sent EUR higher with upward revisions to the ECB’s growth forecast and an optimistic inflation forecast for 2017 of 1.8%, conveniently just hitting their target of “close to but below 2%” and therefore precluding extending QE past the Sep. 2016 cut-off date. But the rally quickly ended after he said that the ECB would not buy bonds below the deposit rate of -0.20%. Since German two-year yields were trading below that level before the announcement, it implied that they will have to buy bonds further out the German yield curve, meaning more curve flattening and further reduction of the risk premium on long-dated euro assets. This makes European bonds less competitive with Treasuries or Gilts and therefore this could weigh on the common currency. Draghi also said that the Bank would have no problem in finding enough bonds to buy and noted that half the Euro-area debt is held outside the Euro area. This implies that a lot of the sellers will be foreigners, who are likely to take profits on their EUR bonds and reinvest the money in higher-yielding Treasuries or Gilts.

The dollar’s strong performance came in the face of more negative surprises as initial jobless claims edged higher and US factory orders fell for the sixth consecutive month (contrary to expectations of a rise). US economic news continues to disappoint — perhaps due to the snowstorms or the port strike — while European news continues to surprise on the upside. It doesn’t matter though; it’s the divergence in monetary policy that matters, and the US seems headed towards tightening while Europe is clearly committed to QE. San Francisco Fed President John Williams, a voting member of the FOMC, yesterday said that mid-year may be time for a “serious discussion” about raising interest rates as the labor market nears full employment and inflation rebounds. The behavior of the FX markets though is in contrast to that of the equity markets; the S & P 500 is up 2.1% year-to-date in local currency terms, while the Eurostoxx 50 is up 15%.

USD/JPY is opening in Europe today back above 120, the third break of that level this year. The rise is significant, given that all we’ve heard recently from Tokyo are comments about the negative impact of the weak yen. For example, BoJ Board Member Takahide Kiuchi yesterday said small companies he met with had expressed the view that the weak yen is pushing up costs for them. The previous two times USDJPY went above 120 it wasn’t able to maintain it for very long. If USDJPY can stay above 120.00 for today, it may signal a new trading range for the pair.

Today’s highlights: Today is NFP day! The market consensus is for an increase in payrolls of 235k in February (one standard deviation range: 210k-260k). That’s down from 257k in January, but would only be a return to normal after the astonishing increases in recent months. On Wednesday, the ADP report showed that the private sector gained more than 200k jobs last month, suggested that nonfarm payroll figure may come in over 200k again for the 12th straight month, consistent with a firming labor market (although there is a lot of variation between the ADP and the NFP reports). In such a case, it will show that the US economy has added at least 200k jobs for 13 consecutive months. At the same time, the unemployment rate is forecast to have tick down one notch to 5.6% from 5.7%.

While much of the US economic data has been disappointing recently, as mentioned, jobless claims plunged the week that the payroll data was assembled, suggesting that today’s figure may avoid the worst of the weather-related disruptions. (New England saw a series of snow storms and Chicago recorded the coldest February since 1875.) Tax receipts have been trending steadily higher, implying that the pace of labor market growth remains steady as well.

On a less positive note, the rise in average hourly earnings is expected to have slowed a bit on a mom basis but remained stable at 2.2% yoy, still well below the 3% or more that was usual in previous recoveries. However, the slight deflation in the headline CPI released last week boosted real average earnings, confirming the Fed’s case that the labor market continues to improve. Even if the market gets worried about stagnant wage growth and sells the dollar, the setback should be limited as the currency will likely remain supported by the much more active easing taking place by other central banks internationally.

As usual, the dollar’s trend going into the employment report is almost more important than the report itself. Given the strong underlying demand for USD, any disappointment on a weak report is not likely to last long as buyers are likely to take advantage of any dips, in my view.

As for the rest of the indicators, Eurozone’s final GDP for Q4 is forecast to confirm the preliminary print and show a rise of 0.3% qoq.

From Norway, we get industrial production for January, but no forecast is available.

Canada’s building permits for January are also coming out.

Today we have speeches from Riksbank Governor Stefan Ingves and Dallas Fed President Richard Fisher speaks. Both spoke on Thursday as well.

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