Today, the US employment report for January will captivate market attention. The forecast is for nonfarm payrolls to have risen by 175k, more than the 156k in December. This would be a number consistent with further tightening in the labor market. We see upside risks to the NFP forecast, considering that the ADP report for the month crushed expectations and came in at 246k, and that the employment sub-index of the ISM manufacturing PMI rose notably. The unemployment rate is expected to have held steady at 4.7%, while average hourly earnings are expected to have slowed on a monthly basis, albeit slightly. We don’t think that a modest slowdown in earnings would be particularly worrisome, given the strong acceleration in December. As such, we believe that this could be another month of solid employment gains in the US economy, something that could bring forth market expectations with regards to the timing of the next Fed rate increase and thus, reverse some of the dollar’s recent losses.
Looking ahead with regards to employment, we see the case for a modest slowdown in nonfarm payrolls from February onwards. The Trump administration has frozen hiring in the public sector immediately after the President took office. Even though this is unlikely to impact January’s NFP print that much, since the freeze was only in effect for one third of the month, it is likely to shave some thousands of jobs off the NFP prints in coming months.
USD/JPY traded lower yesterday, but hit once again support at the 112.00 (S2) barrier and rebounded back above 112.60 (S1). The fact that the rate is back within the range between that support and the resistance of 115.50 makes us keep our flat stance with regards to the short-term path. Nevertheless, there is the possibility for the pair to trade higher within the range, especially if the NFP number surprises to the upside. At the time of writing, the pair is testing the 113.25 (R1) level, where a break is possible to initially aim for our next resistance of 114.00 (R2).
The pair also experienced some rollercoaster trading overnight, primarily due to the BoJ’s bond-buying operations. As was reported, the BoJ bought fewer bonds than market participants had anticipated, sending yields on JGBs higher and the pair lower. However, this reaction was short-lived, as the BoJ announced in the following hours that it is willing to buy 5-10 year JGBs in unlimited amounts, though at fixed rates. This dovish commitment caused USD/JPY to rebound and trade even higher. As we have stressed in the past, given the BoJ’s more or less "passive" yield-control framework, we think that the direction of USD/JPY is likely to be determined primarily by developments in the dollar, and less so by news surrounding the yen (unless in the case of a global risk-off event). As such, we see the case for the pair to gain in coming days, supported by solid US employment data and some clarity around Trump’s fiscal plans.
BoE remains neutral; signals it will continue to overlook inflation
The Bank of England kept interest rates unchanged yesterday via a unanimous vote, as was widely expected. We received a plethora of signals from policymakers, but none more important than the fact that they remain willing to "look through" above-target inflation, suggesting that borrowing costs are unlikely to be raised anytime soon. However, "some" members of the MPC have moved a little closer to their limits for tolerating such an overshoot. In our view, this suggests that there may be growing division among the MPC with regards to whether policy should be tightened in the future in order to curb inflation, which makes us believe we are likely to see some hawkish dissents in the upcoming policy meetings. With regards to the economic forecasts, the Bank raised its GDP growth expectations for 2017 to +2.0% from +1.4% previously, though it kept its inflation forecasts for the next years more or less unchanged.
GBP/USD spiked somewhat higher on the decision to hit resistance a few pips below the 1.2720 barrier, perhaps as a result of the notable upgrade in the GDP forecasts. However, it quickly reversed its gains and tumbled even lower in the following minutes, as investors read through the meeting minutes and found very few hints regarding the possibility of a rate hike in the foreseeable future. This may have pushed back expectations for the next BoE rate hike, thereby triggering a fresh round of selling in the pound. The pair hit support near the 1.2505 (S1) level, and if the bears manage to overcome it on a potentially strong US employment report, we could see the rate testing the 1.2465 (S2) minor support or the 1.2410 (S3) key obstacle.
Our view with regards to the broader direction of the pound remains cautiously negative, for two factors. Firstly, the BoE has signaled that speculation regarding policy tightening is still premature at this stage, implying that sterling is unlikely to get any support from market expectations regarding BoE rate hikes. On top of that, political developments are not likely to support the pound either. With what we know so far, the outlook suggests we are headed for a "hard Brexit" as we approach the triggering of Article 50 in March. Therefore, we think that the latest relief rally in GBP/USD – triggered in the aftermath of PM May’s speech – could be reaching its final stages. Even if we were to see another rebound in Cable, it is likely to remain limited below the key zone of 1.2850, in our view.
As for the rest of today’s highlights:
During the European day, we get the final services PMIs for January from several European countries and the Eurozone as a whole, though the final figures are usually not major market movers.
In the UK, the services PMI for January is due out and the forecast is for the index to tick down, but to remain elevated notably above the key 50 barrier that separates expansion from contraction in the sector. A modest decline in the index may hurt sterling somewhat, but considering that the survey is expected to indicate that the economy’s largest sector continues to perform at a robust pace, we do not expect this to influence the BoE’s outlook.
From the US, besides the jobs data we also get the ISM non-manufacturing PMI for January and expectations are for the index to decline slightly, but to remain well-above the 50 mark. Even though this may prove somewhat negative for USD, we think that the currency’s short-term direction is likely to be decided by the employment data. We also get the nation’s factory orders for December.
We have only one speaker scheduled for today: Philadelphia Fed President Patrick Harker.