Nonfarm Positive Surprise: Shouldn't USD Rally?

The employment report was far stronger than expected as the US data has really tried to turn the corner this week after this report and the ISM manufacturing data. The initial reaction was for a USD sell-off today - but why?

US employment report

The US employment report looked quite strong on the surface, with a private payroll increase of +40k (Here's a link, by the way, to the full report from the US BLS, it's actually rather enlightening to look through the details, which don't look particularly impressive this time around, considering that two of the three largest growth categories in payrolls were a 28k increase in health care workers (more of a cost to society than a source of growth) and a 17k increase in temporary office workers. These are not huge numbers for an economy that has over 300 million participants, though, of course, it is at least not a sign of further deceleration in the economy at the moment (the Jul. revision added +36k to the private payrolls as well - though the irony here is that this makes the August number look like a decrease in momentum from July). The unemployment rate increased slightly to 9.6% as expected and the other numbers were fairly healthy as well, with earning increasing more than expected and the average weekly hours stable at 34.2.

US Employment report: market reaction and market logic

Here is the market's apparent logic of late: we supposed to sell the USD because the economy in the US is looking so terrible and weak data means ever lower US yields and a Fed that will devalue the USD to save the economy. If the data in the US is good, however, we should also sell the USD because this is good for risk appetite in general and the US economy is still weak on a relative basis and there are far better growth opportunities elsewhere.

In this logic, it appears that the only upside for the greenback is if the data is bad for the US and the market decides to get negative on the rest of the world as dashed hopes abroad trigger a reversal of the structural short USD trade. This just somehow doesn't seem fair: at least EURUSD ought to sell-off here in the short term regardless of the direction in risk appetite as good news this week for the US really flies in the face of the prevailing picture heading into this week of a collapsing US and resilient Europe. Ditto for GBPUSD, as the UK has seen a few ugly numbers this week relative to expectations.

(Note: of course, as we write this EURUSD and GBPUSD went from spiking higher to reversing, underlining that the upside argument here for those pairs is difficult to support)

Chart: GBPUSD

GBPUSD continues to play cat and mouse with the 55-day and 200-day moving averages. Seems like the good data ought to see more support for the greenback in this pair, but let's see what happens after the ISM non-manufacturing.

Of course, on the commodity currency side, the pro-risk currencies are rallying strongly on the risk appetite response to this report and they will only reverse if the market decides it is over-reacting here.

Japan

We asked the question yesterday whether the biggest reaction to this data would be in the JPY due to the interest rate implications off a surprise in the US employment numbers, and that has indeed proved to be the case as AUDJPY and NZDJPY absolutely exploded off the strong US data today (mean reverters are probably salivating now if they have a look at that AUDJPY chart in particular - that pair has not gone anywhere for 6 months and always seems to reverse once something gets going). The Bank of Japan is holding its regular meeting early next week after having held a special meeting this Monday that resulted in the liquidity enhancing announcements that everyone basically shrugged at.

The long end of the Japanese yield curve has been going wild all week this week in a steep sell-off in JGB's. In absolute yield terms, this has been approximately equal to the sell-off in US treasuries (using the 10-year duration) from the low on an absolute yield basis at around 25 bps, but from the basis of a relative starting point (JGB's yielded 91 bps before the sell-off compared with the US' 241 bps), the move in JGB's looks more impressive. Does this suggest that the bond vigilantes are on the loose? There is partial confirmation of this in CDS prices, which have risen slightly for Japan over the same time frame - perhaps as the market priced in the official response to the stronger JPY - while CDS prices have fallen rather sharply for the US and other countries. This development bears watching next week to see if it blossoms.

Chart: AUDJPY

JPY crosses reacted the most off the US employment report as the bottom suddenly dropped out of the bond market after the US employment report and AUDJPY proved the highest beta cross among the G-10. Those hoping for a trend, however, have been disappointed since May, as every rally and every sell-off has failed to blossom. Very interesting to note this time, however, that this is the first time the pair has traded above the Ichimoku cloud since before the May mini-crash in equities. For the rally to remain supported, we will need to see continued downside for bonds (higher yields)

Looking ahead

Let's see if we get a strong ISM Non-manufacturing number today, which would provide a hat-trick of positive US data surprises this week. If the number is weak, it could throw the reaction to the nonfarm payrolls report into confusion and might possibly scramble the risk appetite picture, since the ISM number should carry more weight than the

Don't forget that this is a three day weekend (Labor Day) in the US, and that today is widely considered the official end of the summer. The question going into next week is whether it is worth fading any exuberance off today's number - it really appears that the market is clutching at straws if it wants to take away too much from a summer-time employment report - the more important reports await starting with September, which is seasonally when job firings begin to pick up.

It's worth point out on the Australia housing bubble watch that the AiG construction index will be released on Monday in Australia. This index showed a steeply recessionary 43.3 reading in Jul. and was below 50 in June as well, suggesting that construction activity is tailing off rapidly in Australia. But when will the market take note? As long as copper prices are booming and equities aren't falling and the hopes of another round of Chinese stimulus are in the air, it is tough for the Aussie bears to have their way.

Stay careful out there as ever.

Economic Data Highlights

• Australia Aug. AiG Performance of Service Index out at 47.5 vs. 46.6 in Jul.
• Japan Q2 Capital Spending fell -1.7% YoY vs. -6.5% expected and -11.5% in Q1
• China Aug. Non-manufacturing PMI out at 60.1 vs. 60.1 in Jul.
• China Aug. HSBC Non-manufacturing PMI out at 57.6 vs. 56.3 in Jul.
• Norway Aug. Unemployment Rate fell to 2.9% vs. 3.0% expected and 3.0% in Jul.
• Switzerland Aug. CPI out at 0.0% MoM and +0.3% YoY vs. 0.0%/+0.4% expected, respectively
• UK Aug. PMI Services out at 51.3 vs. 52.9 expected an 53.1 in Jul.
• EuroZone Jul. Retail Sales rose +0.1% MoM and +1.1% YoY
• US Aug. Change in Nonfarm Payrolls out at -54k vs. -105k expected and -54k in Jul.
• US Aug. Change in Private Payrolls out at +67k vs. +40k expected and +107k in Jul.
• US Aug. Unemployment Rate out at 9.6% as expected and vs. 9.5% in Jul.
• US Aug. Average Hourly Earnings rose +0.3% MoM and +1.7% YoY vs. +0.1%/+1.6% expected, respectively
• US Aug. Average Weekly Hours were steady at 34.2 as expected

Economic Calendar Highlights

• US Fed's Evans to Speak on OTC derivatives (1345)
• US Aug. ISM Non-manufacturing (1400)
• US Fed's Lockhart to Speak (1400)
• Australia Aug. AiG Performance of Construction Index (Sun 2330)
• Bank of Japan starts two-day BoJ meeting Monday