Euro: Unable to Break 1.49 (page 1 of 2)

DailyFX Fundamentals 02-01-08

By Kathy Lien, Chief Strategist of DailyFX.com

Why Did the Dollar Rally on Negative Non-Farm Payrolls?

Earlier this week, the Federal Reserve told the markets that the reason why they lowered interest rates by 50bp to 3 percent was because the labor market is weak. However, the severity of the problems with job growth was not clear until the release of this morning's non-farm payrolls report. In the month of January, non-farm payrolls fell for the first time in 4 years. The 17k jobs that were lost, makes it difficult to argue that the US economy is not already in a recession and as a result, the Federal Reserve will need to continue to lower interest rates. Unless there is a strong rebound in job growth during the month of February, it is realistic to expect a back to back half point rate cut. Given the weakness of the non-farm payrolls numbers and the implications for where interest rates are headed next month, the US dollar should have sold off, but it didn't. There are a number of reasons to explain this bizarre price action. First, another 50bp was already priced into the futures market and even though there was a knee jerk reaction across the financial markets, traders quickly realized that nothing has changed. Bond yields are only off slightly and rate cut expectations remain the same. We also have over 6 weeks before the next interest rate decision and surprisingly strong retail sales, consumer prices or February non-farm payrolls could easily change the Fed's outlook on interest rates. Also, not all of the news released today was bad news. The unemployment rate declined to 4.9 percent from the psychologically crippling 5 percent level while manufacturing ISM rebounded strongly in the month of January. Prices paid also surged to the highest level in 18 months, reflecting growing inflationary pressures. On top of that the ECB announced that they will no longer be extending their dollar lending facility. According to IFR Markets, there has been speculation that some accounts have been borrowing the cheaper USD facility and using it to fund higher cost positions such as EUR and GBP. When the ECB put an end to that today, these accounts might have bought back dollars to repay their loans. In the week ahead, the US economic calendar is light with only factory orders, service sector ISM and pending home sales due for release. We continue to expect most of these numbers to be dollar negative.

Euro: Unable to Break 1.49

For the EUR/USD, the 1.49 price level seems to be an insurmountable barrier. Eurozone economic data was stronger than expected and US data was weak, but still the Euro failed to close above 1.49. Despite the strength of the currency and the deterioration of US growth, manufacturing activity actually accelerated in Germany, France and Italy during the month of January. Data such as this is the primary reason why the European Central Bank remains stubbornly hawkish. They will be meeting to decide on interest rates again next week and even though rates are expected to be left unchanged for the eighth consecutive month, all traders should keep an eye on the comments made by ECB President Trichet at the accompanying press conference. Will he express any concern about growth or will he focus completely on preventing inflation from having second round effects on the Eurozone economy. Meanwhile Switzerland also reported improvements in manufacturing activity with the Swiss PMI index rising from 61.3 to 61.6. Swiss consumer prices are due for release next week and even though they are expected to drop, it will not alter the Swiss National Bank's plans to keep interest rates unchanged.