Dollar Soft ahead of US Payrolls

BBH CurrencyView

• The dollar is trading on an easier footing as risk improves ahead of payrolls and hope of EZ action
• US private payrolls expected to come in at 150k; strong report likely to be supportive of sentiment
• Merkel calls for treaty changes in order to make way for fiscal union; India reviewing FX policy

The dollar is trading on an easier footing as risk appetite improves ahead the last US payrolls report for this year and hopes of a more aggressive policy response from euro zone officials. As a result sovereign yields in Italy, Spain and Greece are all lower and the euro is currently trading near 1.35. Global stocks continue to advance, with the EuroStoxx 600 extending its largest weekly rally since November 2008, up 1.3%. Merkel confirmed that she is looking for treaty changes and steps towards a fiscal union, though she remains opposed to Eurobonds or more aggressive ECB action. Germany and France will meet Monday to talk strategy ahead of the December 9 leader’s summit. On the data front, Canadian employment tumbled (-18.6K vs. +20k), while UK’s construction was seen lower.

This week growth sensitive currencies have consolidated some of their recent loses with the dollar and Scandis all advancing by more than 3.4% against the dollar. This price action was driven by hopes of progress of the euro zone debt, together with supportive measures adopted by global central banks to deal with liquidity issues. But an important part of the recent bounce in risk appetite continues to be the strong performance of US economic data. US economic data has surprises have in fact continued to outstrip most of its G10 peers over the past few months. As a result, market sentiment has been able to gradually improve amid hopes that the US economy could continue to grow in spite of the ongoing financial stress in Europe. Employment data continues play an important role in these surprises this week with the ADP exceeding estimates by more than two standard deviations. And while the nature of positive data surprises suggest that mean reversion is likely (as economists pencil in higher forecasts to compensate for the miss), we suspect the upside surprise in ADP and the employment components in the survey measures are likely to support a print above the market consensus of 150k. There is very little skew in the consensus distribution (and therefore little directional bias) but we expect a better than expected print today to support growth sensitive currencies. Indeed, we continue to highlight that due to extreme market positioning and overall negative sentiment better US data is negative for the USD. Above all, further resilience in the employment data, together with hopes of more aggressive policy action from the ECB and EZ policy makers, suggests growth sensitive currencies could maintain positive momentum into the weekend.

Ahead of the year’s last US payrolls report there is very little European news to drive price action (outside of Merkel’s speech today where continues to push for Treaty changes and a stronger fiscal union). Yet some observers hope that the meeting between Merkel and Sarkozy next week will provide a step towards greater fiscal unity and discipline. Indeed, as we have recently argued euro zone leaders need to learn to adapt and innovate (and of course move closer towards integration) if the system is to survive. This has yet to be the case and policy makers so far have fallen into the trap of taking small, largely ineffective steps, which do little to garner market confidence. We continue to believe that tighter fiscal coordination is a minimum requirement, together with a backstop for sovereign debt, be it the IMF, the ECB or a combination of both. What’s more, the ECB has recently hinted at more bond purchases if rule on fiscal oversight were tightened, suggesting the ECB is likely to respond more aggressively to financial stress in Europe if prospects of moral hazard are mitigated.

Comments out of India today suggest that the government is finally reviewing its hands-off stance FX policy. The Finance minister noted that, along with the RBI, they are trying to find ways to increase the supply of FX in the market. This includes liberalizing trade credits and raising interest rates on non-resident deposits. Aside from being the worse performing currency in Asia in the last few months, the stronger rhetoric is probably a reaction to increased concerns over FX loan mismatches in the corporate sector. The RBI – along with Mexico until recently – was one of the last central banks to maintain their non-interventionist approach. While this is a positive development for the INR we don’t think the RBI’s commitment is as strong as that of the central banks of Indonesia or Korea, for example. India still offers the weakest policy backstop against further currency depreciation amongst major EM countries and combines one of the worst fundamentals. However, in light of the extreme pessimism already priced in to INR, we would not be surprised to see the currency outperformed the region in the near term if risk appetite remains buoyant ahead of the December 9 EU summit.