US employment in focus on FX markets, says BMO’s Greg Anderson

BMO Capital Market’s global head of FX strategy Greg Anderson says that markets are awaiting further US employment reports before deciding which way to push dollar rates.

With the USD rallying sharply yesterday, a good report has the potential to either extend yesterday’s cycle highs in the USD against currencies like AUD and BRL.

However, a weak report that causes expectations of Fed taper to shift later has the potential to make the USD tumble against those same currencies and perhaps the JPY.

The employment report contains many pieces of information from two different surveys (household and establishment). Markets typically pay the most attention to the change in nonfarm payrolls from the establishment survey. The change in nonfarm payrolls has averaged 191k over the past 12 months. For the first half of 2013, the average is slightly higher at 202k. And importantly, revisions have generally been upward. A Bloomberg survey of 48 analysts has a median expectation of 195k-an average report.

One interesting side note to the jobs number is the ongoing discussion of how many jobs per month is necessary for the unemployment rate to remain flat.

Common wisdom is that the figure is about 130k, which equates to a 1.0% per annum growth rate in the labor force. However, a recent report by the Chicago Fed postulated that recent demographic changes have put the monthly payrolls increase that would match labor force growth and therefore keep the unemployment rate steady at just 80k. But whether the figure is 130k or 80k, it is a bit curious that the unemployment rate in June (at 7.6%) was no better than in March (7.6%) after 3 very solid jobs reports with jobs increases of 199k, 195k and 195k.

There are differences between the household and establishment survey that are basically random noise, but in the long run the two reports tend to converge in terms of their general statement of the labor market. Perhaps for that reason the market expectation is for a drop in the unemployment rate to 7.5%. That is also BMO’s house call. My personal view is that are overdue for a 2 or 3 tenths drop in the unemployment rate. The last 3-tenths decline (at least rounded) was in September of 2012.

I would characterize FX markets as just slightly long of USD coming in to report. According to the latest Commitment of Traders report, short AUDUSD is the one place where positioning is extreme. I would advocate buying AUD as the best day-trade response to a weak employment report, with particular focus on the unemployment rate given its role as an FOMC ‘target’. However, if the unemployment rate drops 2 or 3 tenths, which I would view as the more likely outlier scenario, I would buy the USD against everything, but would focus most on USDJPY. For those with the appetite and mandate, I think USDMXN or USDZAR could have even more upside than USDJPY on a positive shock that sends US 10Y yields to new cycle highs.

 

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