Markets Cautious Ahead of Non-Farm Payrolls

BBH CurrencyView

• Dollar is mostly firmer ahead of NFP report; Stocks in Europe were impacted by new credit concerns
• Market expecting a good number following ADP; USD/JPY likely to firm off the back of higher yields
• The Brazilian real was the best performing currency yesterday; China reports data earlier than expected.

The markets are relatively quiet ahead of today’s US payrolls reports but there was evidence of risk aversion as the European session progressed. The euro headed back below $1.43 following yesterday’s gain as euro zone periphery spreads remain wide amid general banking sector concerns and rumors that Italian Finance Minister Tremonti could be forced out. Cable remains soft despite an early session a run-up ahead of $1.60 following a better-than-expected PPI print Euro zone debt concerns and corrective action ahead of US NFP kept the Swiss franc underpinned, with EUR/CHF down 0.2%. Asian equities posted a moderate rally, which has led to the third consecutive week of gains. Japan’s Nikkei rose by 0.85% late in the Tokyo session, with cyclical stocks moving higher amid signs that Japan’s economy will post a strong rebound after the earthquake. European stocks were affected new EZ credit concerns, linked to a draft EU document on bank stress tests that said banks that fail this year’s tests may be required to present plans for making up their capital shortfall by the end of September.

The key event this morning will of course be the June NFP report, with markets expecting an upside surprise given the strength of yesterday’s ADP report. In addition, the combination of the strength of the employment components of the recent business surveys, higher listing of job advertisements and the trend in initial jobless claims also support the notion of a better-than-expected print. The Bloomberg NFP consensus is 105k but according to the median estimates that were provided following yesterday’s strong ADP report the market consensus is more likely closer to 120k, with the unemployment rate expected to drop by a 0.1% to 9.0%. In any event, June’s payrolls are likely to be much stronger than the previous month’s but what is likely to constitute a strong report? A rolling three-month moving average of the monthly NFP change suggests a trend of 160k, which is down from 220k in April and likely indicating the magnitude of the downside surprise in last month’s report. The trend rate over the past 5 months, therefore, is likely closer to 175k. That said, although a number better than the market consensus is likely to constitute an upside surprise something in the range of 125 -175k is probably a better gauge of market expectations. Indeed, the softer report in May is likely to prove an aberration based on the temporary factors that impacted the economy in Q1 including: 1) supply chain disruptions from the Japanese earthquake 2) the 25% increase in oil prices over the course of Q1 3) inclement weather in some parts of the country. A number within this range of expectations is likely to be supportive of broader risk appetite but is unlikely to be supportive of broader dollar strength. For the most part over recent history, the dollar has traded off the risk appetite implications of the jobs report, where the dollar has fallen on a better number as equities and commodities advanced. Barring a big downside surprise, this is likely to be the outcome today given the market’s reaction to yesterday’s large upside surprise in the ADP, which led the dollar to decline against most of the majors and EM currencies. From the interest rate channel, however, where a strong NFP report prompts a Treasury decline, the dollar is likely to advance against the yen with a test the 200-dma near 82.00 the most likely outcome.

The Brazilian real was the best performing currency yesterday with USD/BRL falling 1% to 1.5538 after President Dilma Roussef stated that she has not authorized FX measures to contain BRL appreciation. The announcement directly contradicted comments by her finance minister Guido Mantega just days ago suggesting that FX measures were imminent. USD/BRL is now free to break the 1.55 level and move towards the key 1.50 level should risk appetite hold up. Mexico’s central bank meets today and recent data support our view that Banco de Mexico will be in no hurry to tighten. While CPI came in slightly higher than expected in June, flat m/m vs. -0.1% expected and -0.74% in May, the y/y rate of 3.3% remains well within the 2-4% target range. With the US economy hitting a bit of a soft patch, Mexico’s real sector has also been impacted. With Mexican price pressures muted, the central bank can take a wait and see approach for an extended period until the economic outlook is clearer. Markets expect the start of the tightening cycle in Q1 12, but that will depend in part on whether the US accelerates in H2 11 as the Fed expects. Still, Mexico rates at 4.5% should be enough to attract investors as long as risk appetite holds up.