John Hardy who will be speaking at our trading event considers the dollar’s fortunes
WE’VE got a pair of important event risks for the US dollar for the rest of this week, including the April ISM non-manufacturing survey on Thursday and the always hotly anticipated US employment report on Friday. These event risks will be critical for testing whether the dollar is set to fall further across the board if it can regain altitude off rather important support levels.
ON THE WINGS OF A DOVE
Last week’s US Federal Open Market Committee (FOMC) monetary policy statement release and Bernanke’s press conference provided an important prelude for the action in dollar pairs this week: the new monetary policy statement was virtually unchanged, but the changes in the FOMC economic forecasts and monetary policy forecasts were fairly hawkish. Nonetheless, the market more or less only chose to pay attention to the press conference, at which the perma-dove chairman promised that the Fed would act if conditions warranted.
The dollar has generally suffered since the FOMC meeting, even as central banks elsewhere have only in rare instances moved in a hawkish direction. The Bank of England (BoE) is a notable example, although the flying sterling-dollar rate of late has come from the BoE merely considering taking its foot off the monetary accelerator as evidenced in its most recent meeting minutes. The key test for sterling and sterling-dollar is next Thursday’s BoE meeting. The recent sterling-dollar action shows that this market, despite its very low volatility of late, seizes on any central bank development with plenty of enthusiasm.
DATA DRIVEN
So what kind of data will we get and how will the market filter that data? We got a surprisingly positive US April ISM manufacturing survey result yesterday, despite a string of weak regional manufacturing surveys in April. But the non-manufacturing survey and employment report should weigh far more heavily, as measures of US economic health and in the Fed’s calculus. Do we get bad US data and will the market see this as more likely to bring another round of quantitative easing (QE) from the Fed and thus counter-intuitively pump asset prices higher and push the dollar even lower?
Or, would bad data see risk assets suffer from the poor growth implications and see the dollar strengthen on the realisation that the Fed tends to only move once the economy and markets are in sorry shape? What about good data? A possible, if less likely, pair of stronger than expected numbers would probably warrant a less complicated and positive dollar response, as this would further delay the prospects of Fed QE. There’s an eventual caveat on that front, however, as we have seen the dollar having a hard time appreciating on positive US growth data, as the Fed is still seen as the last in line to tighten central bank policy if world growth kicks into gear again.
I suspect the risks are that the April ISM non-manufacturing survey and US employment report will be weaker than expected. After all, the US saw unseasonably warm weather and record warmth in many cases in highly populated north-eastern and mid-western areas of the country during the late winter months. This may have brought some demand forward and warped the normal seasonal pattern. Also, the weekly jobless claims indicators have surged higher in recent weeks, suggesting that payrolls growth may have dipped in April. (Although we always need to remember that the official monthly non-farm payrolls release contains extraordinary statistical assumptions and adjustments that are often larger than the overall change in the payrolls.)
POLITICAL SENSITIVITIES
The market reaction is the tough part to predict. Despite my expectations for fairly weak data from the US this week, I suspect that the market is over-estimating the likelihood of near-term easing from the Fed. Yes, the Bernanke contingent holds the reins, but there are a wide variety of views among the voting FOMC members and we also have to consider the political sensitivities of Bernanke in the middle of an election year. Are we really likely to see the Fed tipping off a major new bond-buying programme just ahead of the presidential election? I’m not so sure, even if QE3 is a long-term eventuality. For the next couple of quarters, we’re more likely to see incrementalism and/or extensions of existing Fed programmes at most. So for the nearest term, the dollar might get knocked down another notch or two if the data is bad, but I suspect it will come roaring back in the weeks to come as the US is likely to continue to outperform the pitifully struggling Europe and the Asian exporting economies as well.
John Hardy is head of FX strategy at Saxo Bank and will be on the Masters of Forex panel on 24 May.