Dollar Shrugs Off Non-Farm Payrolls as Traders Look Beyond Q3

TODAY'S BIGGEST PERCENTAGE MOVERS

• CAD/JPY( +217 pips or 2.15%)
• NZD/JPY( +127 pips or 1.75%)
• USD/JPY ( +125 pips or 1.18%)

THE STORIES IN THE CURRENCY MARKET

• USD: DOLLAR SHRUGS OFF NFP AS TRADERS LOOK BEYOND Q3
• EUR: STILL HEADED FOR 1.40?
• GBP: A PAUSE OR A BOTTOM?
• CAD: COULD SEE MORE WEAKNESS
• AUD: BIG WEEK AHEAD
• NZD: EXPECTED TO CUT INTEREST RATES
• JPY: SEASONALITY COULD DRIVE USD/JPY LOWER

EXPECTATIONS FOR THE NEXT FED MEETING (9/16/08)

** PERCENTAGES MAY NOT ADD UP TO 100% BECAUSE OF THE PROBABILITY OF LARGER OR SMALLER MOVES BEYOND THOSE SHOWN ON THIS TABLE

DOLLAR SHRUGS OFF NON-FARM PAYROLLS AS TRADERS LOOK BEYOND Q3

Non-farm payrolls were worse than expected, the dollar sold off but the weakness did not last.Currency traders have become accustomed to disappointing US economic data, particularly from the labor market.Oil prices continue to be the single biggest driver of the US dollar.Crude prices hit an intraday low of $105.13 a barrel, giving traders the hope that beyond the third quarter, the US economy will get better.Although we are skeptical about a recovery, we know that weaker economic data has not stopped the dollar from rallying in the past.

Non-farm payrolls fell by -84k last month, driving the unemployment rate to a 5 year high of 6.1 percent. The most pessimistic components of the report were the unemployment rate, the big drop in manufacturing payrolls and the revisions. The US government said that 9k more jobs were lost in August than previously expected and 38k more jobs was lost in June. Even though we did not get the -100k print that we had expected last month, payrolls in June were revised to -100k. Since the beginning of the year a total of 605k jobs have been cut and we expect at least another 2 or 3 months of negative job growth before the labor market hits a bottom.Over the past 30 years, the US economy has gone through 3 recessions and in each of those 3 recessions, there was a string of job losses that lasted for a minimum of 11 months.

The Federal Reserve's next interest rate decision is in 2 weeks which means that traders will be looking at next week's economic data to determine whether or not the US central bank will raise interest rates over the next 12 months. Fed fund futures are still pricing in 25bp of tightening, but today's non-farm payroll figures have resurrected talk of a rate cut.In the table above, we have added the expectations for a 50bp rate cut.Retail sales and producer prices are the big US releases in the week ahead, but we are also expecting consumer confidence and trade.

EURO: STILL HEADED FOR 1.40?

The sell-off in the Euro accelerated significantly this week with the single currency dropping more than 500 pips to an intraday low of 1.4196.Although the ECB left interest rates unchanged at 4.25 percent, foreign exchange traders dumped Euros on the fear that the higher haircuts on collateral announced by the ECB yesterday would reduce the amount funds provided by the ECB. Following yesterday's sharp reaction in the Euro, ECB officials were out in force trying to calm the markets by saying that the refinement of the collateral rules was not a mini rate hike.

Regardless of whether this is true, it certainly adds further strain on the Eurozone economy and their banking sector.Some banks would be subject to margin calls, which would force them to liquidate positions.The ECB is still more likely to cut interest rates than to raise them and that is one of the main reasons why the EUR/USD could continue to fall and hit support at 1.40.

The economic calendar is light next week but there are many ECB officials scheduled to speak.Given the velocity of the Euro's move and the market's reaction to the collateral changes, ECB President Trichet's speech on Wednesday could be particularly market moving.Besides that, the more important numbers that we expect include Eurozone industrial production and the German trade balance.

BRITISH POUND: A PAUSE OR A BOTTOM?

For the past few weeks, we have been calling for the British pound to fall to 1.75 against the US dollar.The currency came close to doing so last night when it dropped to an intraday low of 1.7538.After falling for eight days straight, we have finally seen some stabilization in the British pound.Given that the currency pair is still overvalued, we would not be surprised to see a move towards 1.65.

Although we have seen improvements in with all three of the purchasing managers' indexes (services, manufacturing and construction), the UK economy is still in trouble.There is a good chance that the UK could fall into a recession, forcing the Bank of England to cut interest rates by anywhere between 50 to 100bp next year.The market is currently pricing in 75bp of easing.The recent weakness in the British pound should help to bolster exports but slower Eurozone growth could limit any major contribution.

It should be a busy week for the British pound with producer prices, BRC retail sales, industrial production, the GDP estimate and the trade balance due for release.We do not expect any major improvements in the data.

AUSTRALIA CUTS INTEREST RATES, NEW ZEALAND TO FOLLOW

It has been a very tough week for the Australian and New Zealand dollars, both of which fell more than 4 percent against the greenback and 5 percent against the Japanese Yen.The Reserve Bank of Australia cut interest rates for the first time since 2001 and the Reserve Bank of New Zealand is expected to follow with their own rate cut next week.This would be the second bout of easing by the RBNZ this year and it would bring interest rates down to 7.75 percent.Given the deterioration in the New Zealand economy and the dovish comments from the RBNZ, their next rate cut should not be their last.As a result, we still believe that the New Zealand dollar should not only hit but also break 65 cents.Aside from the RBNZ rate decision, retail sales and business PMI are due for release, which means that it could be a very volatile week for the kiwi. We also expect some key numbers from Australia.The employment report is due for release on Wednesday while RBA Governor Stevens will be delivering his half yearly testimony on Sunday evening (Eastern).

Meanwhile even though oil prices have fallen significantly, the Canadian dollar ends the week virtually unchanged against the greenback.The IVEY PMI index dropped significantly, reflecting slower manufacturing activity, but stronger employment numbers for the month of August helped to drive the Canadian dollar higher.Unlike Australia and New Zealand, other than trade data, there are no major releases on the Canadian economic calendar.

SEASONALITY COULD DRIVE USD/JPY LOWER

In past editions of the Daily Currency Focus, we have talked extensively about why carry trades could continue to suffer.The current market environment of high volatility, interest rate compression and risk aversion has caused carry trades to underperform significantly.Volatility in the GBP/USD for example has reached at least a 5 year high while the volatility in the EUR/USD hit a 1 year high.However one of the other reasons why the dollar's performance against the Japanese Yen could diverge from its performance against the other majors is seasonality.There is no significant seasonality in USD/JPY during the month of September, but there is a strong seasonality for US stocks.According to a study of 50 years worth of monthly returns for the Dow Jones Industrial Average, the results indicate that September is the month when stocks see the lowest average return (-1.02 percent).Given the current tick for tick correlation between USD/JPY and US stocks, a further decline in equities this month could lead to additional weakness in USD/JPY.There will a lot of economic data from Japan next week including the Eco Watchers Survey, CGPI, leading indicators, industrial production, trade and GDP.

GBP/CHF:CURRENCY PAIR IN PLAY OVER THE NEXT 24 HOURS

The UK and Switzerland have important numbers scheduled for release on Monday. Swiss employment data is coming out at 1:45 AM ET or 4:45AM GMT while UK Producer Prices are coming out at 4:30 AM ET or 8:30 GMT.

GBP/CHF has been trading within our sell zone for the past 3 weeks.Unless the currency pair closes above 1.9875, the downtrend remains intact.Whether or not Friday's recovery is a hiccup within the downtrend will depend upon Swiss employment and UK PPI.The levels that we are watching are 1.9875 for resistance and 1.9495 for support.

Kathy Lien
http://www.gftforex.com

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