Dollar Soft Going into Jobs Report, but Don't Chase

Yesterday's US dollar slump was marginally extended against most of the major currencies today, but the British pound and Canadian dollar.   ECB President Draghi's lack of urgency appears to have awoken the markets out of a slumber.  However, with intra-day technicals stretched, we suspect outside of the early knee-jerk response to the headline news, consolidation will be the main feature going into the weekend.  

With such high unemployment in most of Europe and such low inflation, many are stumped not just by the ECB inaction, but also by it sees no compelling need to do anything.  This would suggest the bar is high against action in April, barring some worsening of conditions.  Remember the euro area composite PMI is above a similar US measure now (EMU 53.3, US mfg 53.2 and non-mfg 51.6). 

However, the frustration with the ECB is misplaced.  What is not sufficiently appreciated, and it is one of our important interpretative points, is that when Draghi says ordo-liberalism is enshrined at the ECB, we should take him seriously.  Often the critique sounds like neo-liberalism fighting ordo-librealism, and talking past each other.  Moreover, ironically, many of the very same financial institutions that argue that the ECB should be engaged in QE, argue that QE elsewhere has not been effective, or artificially distorts the market. 

One area that on his own terms, Draghi can be pushed back against in his arguably too nonchalant attitude toward deflation.  He seemed to attribute it to the fall in energy prices, which would not explain the low core rate (1.0% Feb).  Also, he attributed some of the downward pressure on the euro's strength.   The only thing that should matter here is the euro's valuation on a trade-weighted basis compared with long-term averages.  On a trade-weighted basis the euro is about 2% above its 5 and 10-year moving averages.  

Australia must also be frustrated with the markets.  A concerted effort by RBA officials to talk the currency down appeared to have been working.  Indeed, last week the Aussie's late-Jan through mid-Feb bounce was being turned back.  It finished last week on a poor technical note and at its lowest close in a month.  This week it is the strongest of the major currencies, gaining 2.25% against the dollar and nearly 3.4% against the yen (the only major currency to have fallen against the dollar this week). 

There are three main considerations here.  First, the economic data this week--GDP, retail sales and trade, were all stronger than expected, and the latter two, especially so.  Second, the market says, in effect, that the same conditions behind the RBA's decision to shift from an easing policy to a neutral stance make Australian assets somewhat more attractive.   Third, commodities, as an asset class continue to rally.  The CRB Index is 13% of the lows set in early January.  Industrial commodities have also rallied strongly (though copper is almost 2% today).   

The Australian dollar closed yesterday above the $0.9080 area we identified.  The next immediate target is $0.9165, which corresponds to the December '13 high and the 200-day moving average,  but the bears are likely to wait for $0.9200 before trying again. 

A week ago, the markets were also on edge over China and the pace of its currency decline.  We suggest China was more interested in teaching a lesson than changing policy, though many thought it was a prelude to widening the band or opening the capital account, or the start of a large depreciation.  This week the yuan posted its  biggest weekly gain in four months.   After falling 0.86% last week, the yuan appreciated about 0.3% this week.  

Two factors, however, seemed behind the dollar's bounce today, which pared that yuan's weekly gains.  First, reports indicate the Shanghai Chaori Solar Energy Science and Technology Co has been the first on-shore default in China under the modern configuration of its bond market.  There is some concern that this will start the avalanche of hidden soured debt in China.  We think not.  This is similar to the yuan volatility.  It is more intended to instruct than truly punish.    It is no coincidence, we suspect, that this is happening during the National People's Congress.  Second, important data will be released over the weekend, including trade and inflation reports.  

The US and Canada both report trade and employment data.    It may be going out on a limb, but after the immediate reaction to the headlines, the currency market may find it hard to sustain a trend.  The data is unlikely to alter the view that Fed tapering continues apace (and Dudley reiterated this earlier this week and may do so again later today) and that forward guidance will likely be adjust as the unemployment rate is at the threshold, but for the rounding up.    

While a weak report will be shrugged off as old news (ADP, services PMI) and weather-distorted, a strong number, say close to 200k, would lend credence to a shift from under-appreciating the US slowdown here in early 2014.    There is some downside risk in the Canadian data as well and this warns of potential under-performance of the Canadian dollar.  A greenback more back above CAD1.1040 would improve the technical tone for next week.