Markets Cautious Ahead of NFP

BBH CurrencyView

• The US dollar is mostly firmer across the board ahead of NFP; equities and commodities softer
• US NFP to determine cyclical tone ahead of quiet week; USD/JPY & USD/CHF likely to decline
• UK PMI ebbed, euro zone PMIs revised higher; Greek adjustment plan announcement likely

Equity markets are treading water ahead of the US NFP report, with the Europe Stoxx 600 down 0.5% in the morning European session and the S&P 500 June benchmark down 0.4% ahead of the open.The news that the EU and IMF have completed a second bailout for Greece, staying true to the principle of “rolling over” Greek default risk into the future through conditional liquidity support, has helped shift the market focus away from peripheral woes, leaving the index of CDSs of 15 European governments down 7.5bps at 188.5. This leaves attitudes about the US cyclical outlook and the equities reaction to the NFPs report in the driving seat. The continuation of bullish flatteners in the US yield curve, as investors revert to the view of a QE mode for the Fed for longer, is weighing on the US dollar in a risk cautious, but orderly market environment.

US NFPs to determine cyclical tone ahead of a quiet week for economic events.Wednesday’s disappointing ADP report, concurrent with an uptrend in the weekly jobless claims series and a marked slowdown in output on the production surveys, has prompted a wave of negative revisions for today’s NFPs, pushing the market consensus down to 165k from 185k at the start of the week, compared with a 244k print for April. Indeed, since the dismal ADP report this week subsequent forecasts have a median of 130k, with only seven of the 49 updated forecasts expecting payrolls to exceed 175k. Altogether, it appears that the market is bracing itself for a bad figure but what will this mean for the dollar? Given this overall shift in sentiment, we suspect anything above 165 would now have to be considered a positive surprise, which would likely lead to some knee-jerk dollar buying. That said, we would suggest selling the dollar into rallies as any rally is likely to be short-lived as policy normalization is likely to weigh on the dollar. Conversely, you would probably need an outcome close to 85k or below to really shock the market to the downside. A reading this low is likely to add fuel to the nascent debate about whether the US economy is really in a soft patch or in fact headed for a double dip. In our view, a reading in line with consensus is likely to lead to more dollar selling and combined with the favorable news about Greece are unlikely to trigger a pronounced risk-off event. A subpar reading, however, is likely to see a marked sell-off in risk sensitive currencies with the dollar benefitting from flight to quality as concerns about global growth would likely escalate. In any event, with the distribution of forecasters skewed to the downside we suspect that the report is likely to disappoint, which should continue to weigh on USD/CHF and USD/JPY in particular, while the EUR/USD is likely to remain resilient given we expect to receive positive developments on the new Greek bailout sometime after the NFP release.

Fresh evidence that the Euro zone financial and economic cycles remain disentangled arrived with the EMU services PMI this morning which advanced to 56 for the final reading for May, vs 55.4 mid-month but still down from 56.7 in April. Although the recovery momentum may have peaked (Q1 average of 56.6) the current pace of growth remains comparable to pre-2007 crisis levels, even with Italy and Spain stagnating. That may well be enough for the ECB to announce next Thursday that a further withdrawal of accommodation is warranted with a rate hike in Q3 (July), particularly as European rates have fallen deeper in negative territory in real terms in the past month. In reality this has already been delivered as it is fully priced in. Altogether, it appears that EUR/USD positioning is getting comfortable near $1.45, with a break of $1.455 likely to signal a move towards $1.47. Elsewhere, a much softer than feared UK services PMI is weighing on sterling. The survey excludes retail, but the May reading is the lowest since February, confirming our assessment of the consumer measures that the positive effects of seasonally warm temperatures, Easter and the Royal wedding holidays will prove transitory and the recovery in domestic demand has come to a halt. This is even before the government’s spending cuts have started to show in the growth (GDP, public finances, employment) figures. A slowdown from a position of stagnation in the last six months is a dangerous trajectory and supports our view that the BoE’s monetary bias will move towards neutral with uber-hawk Sentance leaving and the remaining two hawks, Dale and Miles, increasingly seeing the case for a hike as finely balanced. It appears $1.63 holds for now but the pound is vulnerable (0.888 vs euro reached) to further weakness in equities and commodities, while a recent downside break of the 20dma could add to further declines.