Complex Made Simple

ECB President Trichet Faces Very Difficult Monetary Policy Decision

- US Dollar Strengthens, but Some Traders Think the ADP Number is Fishy - ECB President Trichet Faces Very Difficult Monetary Policy Decision - Bank of England: Surprise, Surprise

DailyFX Fundamentals 12-05-07

By Kathy Lien, Chief Strategist of

US Dollar Strengthens, but Some Traders Think the ADP Number is Fishy

Going into Friday’s non-farm payrolls report, the financial market had resigned itself to softer job growth. Today that sentiment was thrown out the window after the shockingly strong ADP employment report. According to the payroll provider, US companies added 189k jobs in the month of November, which was three times greater than the market’s forecast. This number is fishy because it goes against the signals given by nearly all of the other non-farm payrolls leading indicators, but the number is so strong that it cannot be dismissed. Currency traders seem to believe that this number means a lot and perhaps it does, but the price action in bonds and Fed fund futures suggests otherwise. Bond yields are only up marginally and the chance for a 50bp rate cut is still close to fifty-fifty. If the market believed that the strong ADP number translates into a strong non-farm payrolls release, the odds for a half point cut would be back where it was a week ago which is 6 percent instead of 42 percent. Granted private sector payroll growth of 189k does point to non-farm payroll growth in excess of 200k. We think that this forecast is a bit lofty because that would call for the strongest payroll growth in over a year. We do believe that payrolls will be much stronger than the market’s 80k forecast, but probably closer to 150k than 200k. Productivity and factory orders were also better than expected, but service sector growth fell short of expectations. The employment component of the ISM survey slipped to 50.8, which puts it right around the expansionary and contractionary level. Part of the reason why the dollar is strong today is also the hope that Treasury Secretary Paulson will save struggling homeowners from foreclosure by announcing an interest rate freeze on subprime mortgages tomorrow. If this manages to work, we could have some respite for the US economy.

ECB President Trichet Faces Very Difficult Monetary Policy Decision

The European Central Bank will be announcing their monetary policy decision tomorrow and even though rates are not expected to be changed, the ECB decision could be a big market mover. As usual we have our eyes and ears tuned to Trichet’s post meeting press conference. It’s a particularly difficult call for him this time around because inflationary pressures remain very high in the Eurozone with consumer and producer prices well above their target level but growth is beginning to slow. For example, Eurozone service sector PMI edged higher last month but retail sales dropped more than expected in November. In all likelihood, we do not expect Trichet to rock the boat. With such mixed economic data, he will probably reiterate the comments that he made last month. Also do not expect Trichet to use the words strong vigilance because the recent drop in oil price affords him the luxury of postponing another rate hike. We do expect him to remain hawkish however because inflation is at very uncomfortable levels and growth is not that bad. The tone of his comments will be dependent upon whether he recognizes the trend of recent economic data or bases his views on the forecasts for growth in the months ahead. Many central banks believe that global growth will slow and as a result have lowered their growth forecasts for the coming year. Meanwhile Swiss employment data is also due for release. Their labor market remains tight and we expect the numbers to lead to further EURCHF weakness.

Bank of England: Surprise, Surprise

Will the Bank of England be the next central bank to surprise the financial market with lower interest rates? Quite possibly. Going into the BoE meeting, the factors supporting a rate cut include weaker growth, a deteriorating housing market and a sharp increase in LIBOR rates. Arguments in favor of unchanged rates center on inflation which remains at very high levels. The last time the monetary policy committee met, seven out of the nine voters supported unchanged rates while two voters wanted to cut rates. The big question at hand is whether or not a rate cut can or should be delayed until the New Year. Recent comments from Mervyn King and Rachel Lomax reflected the central bank’s reluctance to lower interest rates because they were afraid that if they lowered rates to 5.50 percent they would have a much more difficult time keeping inflation near their target level. If the BoE cuts interest rates, the British pound could test 2.0.

Australia and New Zealand Keeps Rates Steady

The Reserve Banks of Australia and New Zealand kept interest rates unchanged today but left the door open for further rate hikes. To the surprise of the market, the RBA released a statement explaining their move and announced that from here on forward, they will be releasing a statement regardless of whether they alter interest rates. Although they were hawkish to some degree, the market was disappointed by the fact that they said “monetary policy should be maintained for the time being,” which meant that they don’t expect to hike interest rates anytime soon. The RBNZ also felt that inflation would breach their target but there are signs that the housing market is moderating. Both the Aussie and Kiwi appear to be unaffected by the rate decision. Meanwhile the Canadian dollar continued to weaken following yesterday’s surprise rate cut from the Bank of Canada. Traders are betting on weak building permits and disappointing IVEY PMI.

Strong Rally in Stocks Triggers Rebound in Carry Trades

The 196 point rally in the Dow today has triggered a rebound in carry trades as the strong ADP numbers helps to boost risk appetite. Tonight we have leading indicators from Japan which is expected to increase, but that should matter little to the Japanese Yen. Instead, the big question at hand is the Dow and whether we are nearing an important technical resistance point set by the 50 and 100 day SMA.