US nonfarm payrolls report gives strength to the USD
The diverging monetary paths of the Fed and the ECB will probably send the EUR/USD to 1.30 by year end.
Although dramatic movements were not present, today was an interesting day on the Forex markets. The much stronger than expected US nonfarm payrolls figure gave the US dollar a boost for a rally against its Japanese counterpart which sent it to a two-week peak of 102.26, which was the largest USD/JPY gain in about a month.
The Aussie also suffered losses against the USD touching an intraday low of 0.9326 continuing its negative session from the previous day. The heavy losses for the Australian dollar were a direct result of RBA’s governor, Glen Stevens’s, comments that: “the exchange rate remains high by historical standards. There is little doubt that significant parts of the trade-exposed sectors still find it quite ‘uncomfortable’.”
The euro likewise underperformed against the American dollar hitting a one-week low of 1.3597. The selloff was fuelled by the ECB’s press conference at which Mario Draghi once again referred to the downside risks to the euro zone economy only to reaffirm the central bank’s policy of keeping its benchmark interest rates low for an extended period.
What is more interesting to note, however, is the diverging perspective between the euro and the dollar. On one hand, the US payrolls data released on 3 July 2014 showed much stronger job creation than previously anticipated. This is a positive sign for the American economy, which has apparently gone over the contraction in the first quarter. The stronger economic outlook is bullish for the dollar. On the other hand, the euro area has yet to recover from the debt crisis: credit expansion is still weak in countries like Italy and Spain as a result of which small and middle-sized enterprises cannot get access to adequate funding; the strong euro poses significant headwinds to European exporters; inflation, currently at 0.5%, is much below the ECB’s target of 2% which cools down investment appetite and poses the risk of an inflationary spiral to unfold.
The different outlook for the European and the American economy justify the diverging monetary policy paths of the ECB and the FED. The former is continuing to put its arsenal of standard and non-standard measures into action. Last month, it lowered its main interesting rate to 0.15% from 0.25%, cut its benchmark deposit rate into negative territory and offered billions of euros of new liquidity to financial institutions, so that adequate credit flow can be provided to the euro zone economy. Also, it was not the first time when Mario Draghi noted that a very strong euro poses serious challenges to price stability and to European exporters, and that is why the exchange rate was closely monitored by the central bank. Another point made by the ECB’s president was that interest rates were to remain low “for an extended period of time”. Although specific details about asset purchases were not given, Draghi once again mentioned that they were being discussed thoroughly by committee members, a sign that the ECB’s balance sheet is set to grow in the future. All these monetary policy steps are extremely bearish for the EUR.
The FED, in contrast, is in process of winding down its stimulus. The strong jobs figure will most probably keep it on track with tapering its monthly bond purchases, which would mean that the latter would be brought to a halt by year end. Of course, Janet Yellen is not in a hurry to start raising interest rates up, at least not until the FED’s voting members are assured that the labor market is on a solid foot and the inflation outlook starts diverging to the upside from the central banks targets. Even with that in mind, however, the current states of the American and the European economy indicate that the Fed will be the first to start increasing its benchmark interest rates. All that is bullish for the USD.
The dollar index, which hit a one-week high of 80.315, is already giving indications that the dollar will be delivering a strong performance in the mid-term. JP Morgan see the EUR/USD at 1.30 at year end, citing anticipated dollar strength in the coming months. Some other more euro bearish analysts even see the euro breaking below the 1.30 support level by the end of 2014.
