Did NFP Change Rate-Hike Expectations?

Dollar: Did Non-Farm Payrolls Change Rate Hike Expectations?

It took a while for investors to fully digest the non-farm payrolls report. When the number was first released, the dollar spiked lower but regained its footing quickly to race to a high of 119.88 against the Japanese Yen. However the gains failed to last and shortly after the high was reached, USD/JPY u-turned, sold off and ended the day near 118.50. According to the report, over 250k jobs were created in December, more than the market's 240k forecast and the month prior, job growth was revised up to 353k from 321k. While the headline surprise in payrolls was small, the unemployment rate fell from 5.8% to 5.6%, the lowest level since June 2008. Unfortunately in an oversold environment the dollar needed an unambiguously positive labor market report to sustain its rally. The problem was wages. Average hourly earnings dropped 0.2%, which was not only the first decline in more than 2 years but also the largest drop ever. At first investors brushed off the decline but by the end of the North American session both the dollar and stocks traded lower. Monetary policy expectations shifted with Fed funds showing a 52% chance of a September rate hike versus a 57% chance the day prior.

There's no question that investors became less excited about a H2 rate hike after Friday's report but nothing has changed and in fact we believe it will be very difficult for the Fed to justify not raising rates with the unemployment rate at 5.6%. They may not be ready to pull the trigger in Q1 or even Q2 as Fed President and FOMC voter Lockhart suggested but they will do so this year. According to Lockhart, Friday's job report is "very healthy" but "low wage growth suggest job-market slack remains" and therefore "there's no reason to hasten Fed rate increase." With this in mind, he sees an interest rate increase "midyear or later" -- a view that is consistent with the market. Nonetheless, after such a nice run, investors needed a reason to take profit on their long dollar positions and Friday's data gave them the perfect excuse to do so. In the long term, there's also no doubt that the labor market is improving and chances are, the decline in wages will prove to be temporary with the data skewed by lower-paid holiday jobs. While USD/JPY could make another run for 118, we continue to view the pullback as an opportunity to buy at lower levels for an eventual break of last year's high of 121.85. U.S. consumer spending and inflation data are scheduled for release next week along with the Beige Book report. The prospect of lower retail sales growth could limit the recovery in the dollar and give investors yet another opportunity to pick up USD/JPY at lower levels.

Euro Finally Rallies after 10 Listless Days

After 10 listless days, we finally saw a rally in EUR/USD. The recovery was driven entirely by profit taking in the greenback following the US nonfarm payrolls report. Eurozone data continued to harden the case for quantitative easing by the European Central Bank. German industrial production fell -0.1% in November while the trade surplus shrank to 17.9 billion from 22.1 billion. German exports in particular fell 2.1% marking the second consecutive monthly decline. It is widely believed that the Germans oppose quantitative easing but given the recent economic reports including the latest inflation data, they may start to welcome more stimulus. QE would drive the euro lower, bring more support to the German economy and help to reverse some of the downward pressure on prices. The euro could bounce another day or two next week but ultimately the trend ahead of the Jan 22 ECB meeting should be lower. Eurozone trade, industrial production and CPI numbers are scheduled for release but these second-tier reports are not expected to have a significant impact on the currency.

GBP: Watch Out for UK CPI Next Week

Like the euro, the British pound rebounded against the US dollar Friday after 5 straight days of losses. UK economic data was mixed with the trade balance improving but industrial production falling for the second month in a row. Even with Friday's improvements, chances are the Bank of England will have to delay any plans to raise interest rates. There's not much on the UK economic front next week with the exception of consumer prices, which is important considering that the Bank of England has an inflation mandate. What's interesting about the CPI release is that economists are actually looking for a rise in CPI even though consumer prices have been falling around the world due to lower oil prices. On an annualized basis, however, consumer prices are still expected to grow at a slower pace falling below the 1% mark that determines whether BoE Governor King needs to write an open letter to British Chancellor Osborne explaining the decline and their plans to reverse the trend. A rate hike would be counter-productive as that would drive inflation even lower. Sterling could see a stronger rally above 1.52 maybe even to 1.53, which we would look at as an opportunity to sell at higher levels.

CAD: Crushed by Weak Employment Numbers

One of the cleanest trades Friday was to buy USD/CAD. For the most part US employment numbers surprised to the upside while Canadian data was shockingly weak. Economists were looking for employment to rise by 15,000 but instead Canadian employment dropped 4,300 in December. The unemployment rate held steady at 6.6% but the participation rate declined from 66 to 65.9. While it is somewhat encouraging that all of the job losses were in part-time employment and strong gains were seen in full-time employment, at the end the day net job losses weighed heavily on the Canadian dollar. Housing starts also declined while building permits fell a whopping 13.8%. The Canadian economy has been hit hard by the decline in oil prices and Friday we saw further evidence of weakness in the overall economy. While the prospect for stronger US growth could contribute positively to future growth, right now we still have a month or two of negative Canadian economic reports to get past first. Therefore we continue to look for USD/CAD to hit 1.20. Meanwhile the Australian dollar traded strongly Friday while the New Zealand dollar edged slightly higher. Retail sales in Australia grew less than expected but the prospect of stabilization in China lent support to the currency. One of the most important pieces of economic data next week will be the Australian employment report.