Shocking ECB rate rhetoric sees EURUSD spike higher as ECB mulls rate hike as early as next month.

Low expectations for US employment report up today. JPY tumbles across the board on rate focus, risk willingness.

MAJOR HEADLINES – PREVIOUS SESSION

• Australia May Performance of Construction Index out at 36.9 vs. 42.6 in Apr.
• Japan May Official Reserve Assets fell to $997B vs. $1004B in Apr.

THEMES TO WATCH – UPCOMING SESSION
Key Risk Events (All times in GMT)

• France Apr. Trade Balance (0645)
• Norway Apr. Industrial Production (0800)
• Switzerland SNB's Jordan to speak (0900)
• Germany Apr. Industrial Production (1000)
• Canada May Unemployment Rate and Net Change in Employment (1100)
• US May Change in Nonfarm Payrolls (1230)
• US May Unemployment Rate (1230)
• US Fed's Kroszner to speak (1245)
• US Fed's Evans to speak (1515)
• EuroZone ECB's Weber to speak (1600)
• US Fed's Bullard to speak about Housing (1730)

Market Comments

Yesterday we rated a Trichet press conference scenario in which the ECB came out preparing the market for rate hikes as the "biggest surprise" and rated it as a low odds proposition. Yesterday shows what happens when the surprise scenario comes to pass - it appears our view was also the broad consensus view, and the market was shocked out of its complacency once again by a very hawkish ECB. EURUSD briefly touched new lows, only to rally over 200 pips by the end of the day. Trichet said that ECB rate hikes were openly discussed, that some members felt that it was already time to raise rates and indicated that a rate hike could come as early as the July meeting. Clearly, the ECB inflation focus has now become so strong that the council seems determined to focus on inflation regardless of the growth situation. The Fed has recently shown signs of doing the same, but the forward expectations now have the ECB potentially moving far sooner than the Fed in beginning a new hiking regime (Fed watchers are looking out at the fall for the first potential rate hike from the US.)

Yesterday's ECB rhetoric drove the spread between German 2-year rates and US 2-year rates stretched to a strong new high above 200 basis points for the first time in almost 15 years and fuels the argument for a new EURUSD rally from a rate differential perspective. In fact, if EURUSD is to slavishly follow the rate differentials as it has for the last 2 years, we should already be trading at new highs above 1.6000. We have postulated before that the rate differentials haven't always been the one and only drive in the market in the past and that eventually this focus could ease as other factors become more important (valuation, capital flows as global growth slows, etc.). But at the moment the relative rate story seems very important and it would take and awful lot of saber-rattling from the Fed to get the rate differentials headed in favor of the USD. So, this surprise is perhaps large enough to drive EURUSD higher for a while, but the USD may yet fight back within a week or two - after all, we can't forget that it was just two days ago that the Fed introduced the focus on the weak USD for the first time.

In other developments, equities showed a jaw-dropping willingness to ignore the implications of hawkish ECB rhetoric and a 5-dollar rally in crude prices and rallied strongly into the North American close. The move was apparently driven by good news from retailers in the US, especially the stronger than expected chain store numbers for May. The combination of sharply higher interest rates and higher risk appetite were most intensely felt by the JPY, which was driven off a cliff by the market, particularly against the spiking EUR. It appears the market has donned its rose-tinted glasses again and the glass half-empty crowd (which includes us) will have to be patient in waiting for the global growth slowdown scenario to hit risk appetite.

Today we have the US employment report, with a negative nonfarm payrolls expectation for the third month in a row. The unemployment rate is expected in at 5.1% (vs. 5.0% last month). The payrolls number is expected around -50k, but statistical adjustments that are larger than the actual changes to the data make this number notoriously hard to predict. US employment cycles of the past show that the unemployment rate tends to keep on rising for up to three years once it begins to rise significantly, so it will be some time before we can expect sustainable good news on the employment front.

Today we also see the Canadian employment report after yesterday's strong Ivey number. With the latest moves in USDCAD, it appears that the market is willing to ignore good news from Canada and rallies in energy, so a stance of accumulating on dips towards parity might be the way to go there if the pair heads for consolidation in the sessions ahead.

Chart: EURUSD
With yesterday's bullish pattern reversal (new lows strongly rejected and the close engulfing the last several days' action to the upside), the next couple of resistance levels come in at the 55-day moving average around 1.5650 and then the descending trendline coming in around 1.5750. As of this writing, 1.5480 looks like the reversal level if the rally proves unsustainable.