Gain Capital

The US dollar took a pounding after Friday’s NFP report indicated a loss of -4K jobs in the month of August. Revisions to June and July were also negative, compounding the appearance that the US economy is tipping over, weighted down by ongoing real estate declines, higher consumer lending rates and tighter lending conditions. Street analysts are back flipping over themselves to forecast how aggressively the Fed will cut rates at its Sept. 18 meeting, with futures markets pricing in a 75% chance of a ½% rate cut as of Friday. However, I would suggest the situation is not as clear cut as the market consensus seems to expect.

In my update from Aug. 31, I argued that widespread expectations of a Fed rate cut are likely misplaced, given this Fed’s determination not to bail out risk-seeking investors, which is frequently expressed as the ‘moral hazard’ dilemma facing the Fed. Instead, I suggested the Fed would need to see real evidence of an economic slowdown in the form of lower consumer spending and rising unemployment. August’s NFP weakness, coupled with downward revisions to June and July data, certainly could be considered evidence of mounting potential for rising unemployment. But I would first note that August’s NFP weakness is just one month’s worth of negative job creation, subject to revision later. Secondly, despite the negative NFP print, the unemployment rate held steady at a still very low 4.6%. Initial weekly claims have held roughly steady around a 320K average over the last year, registering 318K for the first week of Sept., so there is no discernible confirmation from the weekly jobless statistics either that unemployment is rising.

Other data released last week pointed to a relatively upbeat outlook, most notably a steady reading in the ISM non-manufacturing index at 55.8, comfortably above the 50 boom/bust line, and a nearly 3% YoY increase in ICSC (International Council of Shopping Centers) August chain store sales. Finally, in light of recent comments from Fed officials, which confirm my view that this Fed is not going to bend in the face of markets clamoring for relief, I’m sticking with my view that the Fed remains on hold at its Sept. 18 meeting. Multiple Fed speakers are slated for this week, and if they repeatedly suggest, which some already have, that the Aug. NFP does not necessarily merit an immediate rate cut, then we’ll have further confirmation of the Fed’s wait-and-see attitude.

Does this mean the market might not continue to beat up on the dollar on the expectation of a Fed rate cut? Absolutely not. US Dollar-pessimism appears very high and this is most in evidence by the US dollar index closing last week (79.95) just below the key psychological and technical support level at 80.00 for the first time since 1992. In recent updates I cautioned that a close below 80.00 should be considered as a sign of a new phase of USD weakness, but I’m not entirely convinced that last Friday’s NFP induced-slump in the buck was for real. I’m keeping an open mind and watching closely how the markets treat the US dollar in the early days of this week. Keep in mind that this Tuesday is the sixth anniversary of the 9/11 terror attacks and generally not a time to get optimistic about the USD, but I’m still keeping my eyes and options open.

I would also caution traders not to get too caught up in the negative US dollar-centric themes that seem to have captivated markets on the basis of a disappointing NFP number. Rather than focusing on the USD as the key driver of currency moves ahead, I’m keeping my focus on the prospect for further selling of the JPY crosses. Over the last several weeks and months I have characterized the current market volatility in terms of risk aversion (investor sentiment-driven) rather than fundamentally driven. Last week’s equity market losses and sell-offs in the JPY-crosses (carry trade unwinding) are the real story I think, demonstrating that investors remain exceedingly nervous and uncertain.

Remember, the on-going credit crunch is a global phenomenon and is as likely to undermine other major economies as it is the US’s. Along these lines I would note that European stock market losses on Friday were heavier than US equity declines (about -2.3% for European shares versus -1.7% for the US stocks). In other words, we’re all in this together, and the fallout elsewhere (UK, NZ, Australia, Canada, Eurozone) could be more problematic for growth and interest rate outlooks elsewhere, cycling pressure back onto those currencies.

USD/JPY looks to be leading the way lower in the major USD pairs and closed last week well-below earlier consolidation support around 114.00. That breakdown suggests the JPY-crosses are also entering a new phase of weakness, with likely Asian equity declines on Monday set to increase pressure on carry-trades. If USD/JPY should break down below the lows for the current sell-off, around 111.60-112.00, I would view this as confirmation of a fresh wave of JPY-cross selling. EUR/JPY looks to have similar pivot support at 154.50/155.00, with a drop below confirming fresh JPY-cross selling. As it has in the recent past, heavy (i.e. panic) selling of the JPY-crosses is likely to spill over into the non-JPY dollar pairs, sending them lower against the USD, weak NFP data and Fed rate cuts notwithstanding. This spill-over price action is one way the US dollar index could rebound from the 80.00 level, even while USD/JPY remains heavy.

Turning to the US data calendar for this week, the action begins on Tuesday with the July trade balance, which is forecast to deteriorate slightly and could be another excuse to sell the USD. Tuesday morning also sees the IBD/TIPP economic optimism index for September. Wednesday has only weekly mortgage applications, while Thursday sees only weekly jobless claims. Friday’s data slate is heavy: 2Q current account balance; August import prices; August industrial production and capacity utilization; August advance retail sales and preliminary Sept. Univ. of Michigan consumer sentiment. Focus on the last two data reports to gauge the market’s reaction. Fed speakers are front-loaded for the week, with Lockhart, Yellen, Fisher, and Mishkin on Monday, and Bernanke on global imbalances on Tuesday.