US Dollar Rallies Ahead of Payrolls, but Watch Out for a Disappointment (page 1 of 2)

DailyFX Fundamentals 02-01-07

By Kathy Lien, Chief Strategist of DailyFX.com

US Dollar

In January the main theme in the currency market was dollar strength. This was due to a combination of seasonality and upside surprises in US data. However in February we are beginning to see the tides shift. US data is surprising more often to the downside than to the upside, questioning the sustainability of the impressive growth that we saw in the fourth quarter. This morning we had the national ISM manufacturing index drop right back into contractionary territory to hit the lowest level since April 2003. Having only spent one month in expansionary territory, the manufacturing sector as a whole returned to weakness. The prices paid index rose significantly, but that rise was primarily attributed to the recent increase in energy prices. The employment component of the ISM survey also remained in contractionary territory for the third straight month. This suggests that we could see another month of job losses in tomorrow's payrolls report for the manufacturing sector. As for the non-farm sector, traders are covering their dollar shorts in anticipation of a strong payrolls report. The leading indicators that we usually watch to forecast payrolls are actually mixed which means that payrolls could be more of a coin toss. To start, the number of jobs added to payrolls in the month of December was a very strong 167k. It will be difficult for January payrolls to surpass that level. Secondly, even though jobless claims have been very lean and the ADP Employment Survey is calling for job growth in excess of 150k, layoffs according to Challenger Gray and Christmas increased by 15 percent from last month. Bloomberg's forecast of 81 analysts range from 20k to 225k and the CME payroll derivative auction settled at 136.3k this morning. The price action in the US dollar today indicates that traders are expecting a strong report, which means that the bigger market reaction could be if payrolls fall short of expectations, at which time we could see a major flush in the US dollar.

Euro

The Euro attempted to break out of its three week long trading range but failed to do so as traders covered their short dollar positions following the US ISM report. Eurozone manufacturing sector PMI was softer than expected as activity slowed in Germany, France and Italy. Although the index still remains firmly in expansionary territory, it does suggests that the outlook for the Eurozone economy may not be as promising. The next two months will really be key in assessing the true health of the region and how vulnerable Germany may or may not be to the Value Added tax increase. The solid German numbers that we saw yesterday were primarily for the month of December and the January indicators that we have seen thus far have mostly signaled a slower pace of growth. However this will not shift the monetary outlook for the European Central Bank. They are still expected to raise interest rates in March and ECB Wellink's comments this morning confirm that. Wellink said that interest rates remain low and he sticks to his optimistic outlook for growth. Meanwhile the Swiss franc is stronger despite a softer trade balance and PMI index. The trade deficit narrowed from 1.23B to 0.43B while the PMI survey dropped from 65.0 to 62.0.

British Pound

The British pound is higher against both the Euro and US dollar today thanks to impressive economic data. The UK was the only country to release a stronger manufacturing PMI report for the month of January.