Will the ECB raise interest rates beyond July? (page 1 of 2)

DailyFX Fundamental 07-02-08

By Kathy Lien, Chief Strategist of DailyFX.com

How to trade non-farm payrolls

The US dollar has weakened ahead of the June non-farm payrolls report.

According to payroll provider ADP and Challenger Gray and Christmas, the US labour market deteriorated significantly last month.

ADP reported a 79k drop in payrolls while Challenger reported a more than 46% increase in layoffs.

There is absolutely no reason to believe that the labour market has improved since the only argument for stronger payrolls is strike activity, which has fallen by 8,300 people.

Continuing claims are at the highest level since February 2004 and with Starbucks announcing that they are closing 600 stores, which translate into as much as 12,000 new layoffs, these levels are expected to rise.

Non-farm payrolls is always a big market mover, but this time around, we expect unusual volatility since ECB President Trichet will begin his post monetary policy meeting press conference minutes after the NFP release.

Here is the link to our non-farm payrolls preview and why we think payrolls could drop by more than 100k.

NFP is always dangerous to trade given the possibility of big intraday swings, but USD/JPY should be the currency pair that has the purest reaction to the NFP report because it will not be diluted by the comments from the ECB. It has actually been consolidating for the past three trading days and is itching for a breakout.

The EUR/USD on the other hand could have a knee jerk reaction to the NFP report and then a sharp reversal as traders tune into Trichet's comments.

Don't be surprised by 100 pip candles in both directions. The press conference begins at 8:30am ET, but by the time Trichet starts talking, it is usually 8:40 to 8:45am.

The market expects a bad number, so a negative non-farm payrolls report will not be enough of a surprise. The current forecast calls for 60k jobs to be shaved off US payrolls.

If payrolls come any where near -90k, the dollar would collapse against the Euro as the market questions the viability of a 2008 rate hike by the Federal Reserve.

If payrolls on the other hand are better than -40k, it suggests that the labour market is bad but not as bad as everyone may have feared, which could be dollar positive.

Also keep an eye on the ECB interest rate decision and the press conference. If Trichet remains hawkish and hints that they have to raise interest rates by more than 25bp this year, then the dollar could fall against the Euro even if NFPs drop by less than expected. If Trichet is noncommittal about future rate hikes on the other hand, the Euro could suffer.

Will the ECB raise interest rates beyond July?

The ECB is expected to raise interest rates for the first time since 2007 but the quarter point rate hike will not be the big market mover.

Instead, the recent price action of the Euro indicates that traders expect hawkish comments from ECB President Trichet.

With the annualized pace of Eurozone producer prices growing by the fastest pace on record, consumer spending in Germany doubling expectations and the German unemployment rate falling to a 14 year low, the ECB has to seriously reconsider their original plans to raise interest rates only once this year.

The ECB is a central bank that hates surprises and because of that, they always like to prepare the markets weeks, if not months, in advance of any pending move.