USD looking beyond NFP

As crucial as this week’s release of the US October non-farm payrolls report may appear, the combination of last week’s double blow from the Federal Reserve’s ending of QE3 and the Bank of Japan’s expansion of its monetary policy should cement further ascent in USD/JPY. Any pullbacks are seen as carte blanche to re-enter the pair.   

The current USD rally differs from prior rallies of 2012, 2010 and 2008 in that it is currently accompanied by rising USDJPY. The last time the rising USD included strength in USDJPY was 2005, when the US currency sustained broad advances, resulting from secular US economic strength relative to Europe and Japan. As is the case today.

Dollar bulls ought not to let any disappointment US jobs report distract them of the hawkish manner in which the Fed completed the end of QE3. At last week’s FOMC meeting, the Fed produced a clear upgrade of its view on labour markets by stating that “underutilization” was “gradually diminishing”, while adding that “likelihood of inflation running persistently below 2% has diminished somewhat since early this year”. These changes with regards to inflation and unemployment were the most striking elements of the Fed statement, highlighting its hawkishness and positivity for the US dollar, thereby offsetting the dovish effect of keeping “considerable time” guidance intact. The upgrade on employment and waning of deflationary worries was so stark and sufficient to the extent that arch hawk Philadelphia Fed’s Charles Plosser voted in favour of keeping the “considerable time” guidance. Recall that in the September meeting, Plosser objected to the “considerable time” guidance “because such language is time dependent and does not reflect the considerable economic progress that has been made toward the Committee’s goals”. The fact that Plosser dropped his hawkish dissent highlights internal shift of the discussions shaping the new Fed statement.

US jobs & Fed “latest” guidance

Friday’s release of the US jobs report is expected to show a 234,000 net increase in nonfarm payrolls for October, following a 238,000 increase in September. The unemployment rate is expected to hold steady at 5.9%, the lowest since July 2008. Now that the Fed has set to officially conclude QE3, the next frame of reference for bond and FX traders shall unambiguously fall on the timing of the first fed funds rate hike. But in the event of a disappointing report, such as a figure below 180,000 and/or an unemployment rate above 6.0%, traders should continue to find interest in the US currency. FX markets are all about relative values and the perception of a change in these relative differentials. Last week’s action from the Bank of Japan and the upcoming “inevitable” easing from the European Central Bank will keep these differentials in favour of the USD.

Land of the falling yen

Two days after the Federal Reserve exited its quantitative easing, the Bank of Japan (BoJ) surprised the markets by expanding its own QE and unleashing a fierce wave of buying in global equities, with currencies dominated by USD strength and yen weakness. The BoJ unexpectedly expanded its monetary base by 80 trillion yen per year from the previous 60-70 trillion yen. The plan will also increase the purchase of exchange-traded funds by about 3 trillion yen and real-estate investment trusts by about 90 billion yen annually. The other major factor weighing on the yen was the confirmation from Japan’s Government Pension Investment Fund that it would boost its holdings allocation for both local and overseas stocks to 25% each from 12%. The Nikkei report was later confirmed as the GPIF –the world’s biggest pension fund – announced it will raise its allocation to foreign bonds to 15% from 11%, and reducing domestic debt exposure to 35% from 60%.

USD/JPY has already printed a resh seven-year high of 114.22. Subsequent pullbacks remain seen as opportunities to enter the pair for 115.30s.  With the BoJ diving into fresh easing and Fed policy possibly at its least easy stance since 2008, these times are rare.

Most interestingly about these yen-depreciating policies from Tokyo, they do not face opposition from the rest of the world on grounds of currency wars or competitive devaluations. The main reason to such global approval is the escalating risk of deflation and the negative rate of population growth. These factors give carte blanche to Japan to monetize its debt and encourage investments in foreign assets.

Capping the ECB bounce

Thursday’s ECB meeting is widely expected to keep rates unchanged and open the door for further easing, such as enhancing the terms for the Targeted Long Term Refinancing Operations, due in December. The odds of announcing outright QE (purchases of sovereign bonds) are as low as 20-30%, therefore a the confirmation of holding off QE could give a brief boost to the euro. Nonetheless, Draghi will maintain, if not heighten, dovish rhetoric, by referring to the possibility of unvonventional measures. Managing the euro bounce will be crucial ahead of Friday’s US jobs report.