Payrolls and interest rates to dictate dollar direction

For the G7 markets the Japanese yen is where the action is, especially when it comes to EUR/JPY. A report from The Times of London rekindled speculation that the BoJ is preparing to walk away from direct FX intervention to support the dollar at the end of the book-closing period (end March). As expected, MoF and BoJ officials went on the counter-offensive in early Monday morning Asian trading, denying such claims. Still, it is increasingly evident that the improving fundamentals of Japan are making it increasingly harder for Japanese authorities to defend their FX intervention actions. This April 1st offers the prospect of an improvement in the Q1 Tankan business sentiment survey, while the unemployment rate is also expected to drop to 4.9% this week. A break below USD/JPY 105 is looking like a formality; while the steep descent of EUR/JPY threatens to touch the November lows of 124!

Former Finance Minister Sakakibara ("Mr Yen") said on Friday that it was inevitable that the JPY would keep strengthening towards USD/JPY 100. Newspaper reports that the BoJ would be easing back on its aggressive intervention policy at the end of the fiscal year (end-March) make this week particularly interesting, especially for Friday which also sees the release of the US Non-Farm Payrolls. While the market has become less confident of calling for a very strong number, a worse than expected reading could be a key trigger for the Japanese authorities to let the market take the JPY below 105. Our end Q2 forecast for USD/JPY is 95.

Comments from ECB Governing Council members in recent days have left the market increasingly expectant of interest rate cuts in coming months. In fact a cut is a distinct possibility for this Thursday's meeting. This has been a major factor in the weakness of the EUR in the past week and if anything now it appears that by the time any easing takes place, it may well be a case of buy the rumour, sell the fact. This could mean the EUR has already had most of the negative impact from this. The real test will be if the yield differential between US treasuries and bunds moves in favour of the USD. The 10 year yield differential has narrowed to a mere 10 bps in favour of the bund from the peak of 25 bps seen in mid-March. A shift in favour of the USD would take away one positive for the EUR. We do not believe this will be enough to prevent the EUR continuing to rise in coming months given our view that the fundamentals still point to a weaker USD.

In India, the markets are preparing for Wednesday's Q4 GDP, which may reveal the fastest growth in three decades at 8.8% y/y. The expectations are that low interest rates and favourable farm production are fuelling a consumer boom. Again, the FX market is capturing the turn around in re-inflationary expectations with USD/INR crashing through 45.00 last week. Expect the markets to re-establish their short USD/INR positions ahead of the GDP numbers as the Bombay stock exchange holds onto its all-time record highs. While we remain very sceptical of the claims that "outsourcing" is stealing jobs from the US, any disappointment in Friday's non-farm payrolls numbers leads us to the conclusion: If you can't beat them, invest in them.