Gain Capital

The post ECB/NFP dollar rally looks overdone
In one fell swoop the greenback managed to reverse what was shaping up to be a terrible week, on the back of an NFP number that was seen as in line with expectations and an ECB seemingly on hold following the 25 bps increase. EUR/USD opened the week near 1.5790 and looked poised to break through 1.5800 in earnest, a level it had not closed above since late April. Even the 1.6000 area seemed within reach as EUR/USD crossed above 1.5900 just ahead of the simultaneous ECB press statement/US NFP release. It was not to be, however, as the NFP report was deemed to be in line with consensus (we argue it was worse below) while Trichet was interpreted as telling the market that the ECB is on hold. EUR/USD shot down quickly following Trichet’s comments and was sitting more than 200 pips lower at 1.5690 just hours later. Given other market developments we believe this move was likely overdone.

The fact of the matter is that the US dollar continues to face huge headwinds that are likely to keep it under pressure for some time. Oil prices broke to a new record high this week, nearly hitting the $146/bbl mark and it is becoming ever clearer that we will probably see $150 oil before we see $130 oil again. Moreover, US financial markets continue to reel from an ever present credit crunch and this continues to be reflected in the stock prices of major financial institutions. The S&P 500 financials index hit a fresh five year low this week and has now tumbled more than 47% from the 2007 peak. So clearly the credit mess continues.

In terms of the US economy, we have yet to see signs that a recovery is even remotely close. Data continue to come in sub-par while all of the consumer confidence measures continue to run near the lows back to the 1990/91 recession. The only bright lights have been the pickup in consumer spending and trade. But the endurance of even these two factors is in question as there is nothing to suggest consumer spending will continue to run above trend once the stimulus checks have been spent and trade is likely to come under pressure with global demand likely to get impacted by rocketing inflation around the globe. So clearly the US dollar is encountering more negatives than positives at this juncture.

ECB hikes as expected, but was it a one and done?
The ECB rose rates by an expected 25 bps this week, taking the repo rate to 4.25%. The real market mover, however, was the press statement by ECB President Trichet roughly 45 minutes later. The statement that caught the markets’ attention the most was that the ECB “has no bias” at this point, a declaration that Trichet repeated multiple times in the Q&A session as well. While this makes a compelling case to suggest the latest hike was a one and done event, we believe further rate hikes in 2008 cannot totally be discounted just yet. Indeed, Mr. Trichet noted the bank’s “strong determination” to anchor price expectations and reminded us multiple times that the ECB’s mandate is to keep inflation in check.

With headline CPI currently at 4.0% and twice the ECB’s target rate, we believe the bank is likely more in a wait and see mode rather than a full blown halt. Trichet did not signal further hikes are a lock, saying that the bank “does not pre-commit”, but he also did not signal that they are out of the question. In other words, he was very careful to leave the door open for rate hikes in case inflation continues to rear its ugly head. The futures market is looking for a good chance of another hike by the end of the year, with the December EONIA trading at 4.46% -- 21 bps above the current rate. Thus the inflation data out of the Eurozone over the next few months will prove critical in assessing what the ECB’s next move will be.

US employment data were much worse than expected
The US employment report for June showed that nonfarm payrolls declined -62k (consensus -60k) on the month, while the unemployment rate remained steady at 5.5% (consensus 5.4%). While obvious that the u-rate disappointed, we also see the NFP number as much worse than expected given the back month revisions. The May and April data showed a net revision of -52k that when added to the June headline shows a real NFP change equivalent to -114k. In other words, the number was nearly double the expected decline! This was also the sixth consecutive month of payroll declines and the US economy has now lost roughly 440k jobs in 2008.

The weekly initial jobless claims report, which was released simultaneously with NFP, was yet another ominous sign for US employment. Claims jumped to 404k in the last week of June after an upwardly revised 388k the previous week. The average for the month was roughly 390k and is up from 370k in May. Continuing claims also remained elevated at 3.1 million, as it continues to prove quite difficult for those who have lost a job to find a new one. Across the board it was quite a disappointing report.

The declines in employment do not bode well for consumer spending post-stimulus and are likely to keep the Fed from hiking rates through the balance of 2008. This will prove yet another negative for the buck as the ECB is clearly willing to act if inflation surges to uncomfortable levels while the Fed is handcuffed by its dual mandate to preserve both price stability and economic growth.