By DailyFX - US Dollar: Strong Payrolls Not Enough to Offset Softer Inflation and Weak Income. Living up to its reputation, the non-farm payrolls report...

... delivered some serious volatility to the foreign exchange markets.


An intraday chart of the EUR/USD revealed rollercoaster like price action which
illustrates the difficulty in trading the EUR/USD on non-farm payrolls
day. Interestingly, the cleanest NFP reaction was actually in USD/JPY,
which trended higher throughout the US trading session. Non-farm
payrolls were strong, with corporations adding 157k jobs in the month of
May. Manufacturing ISM also beat expectations, rising to 55.0 from
54.7. However this was not enough to negate the days
disappointments. Personal income dropped for the first time since
August 2005 while spending continued to rise. The spread between income
and consumption is the widest since May 2006, indicating that consumers
are digging deeper in their pockets to fund their purchases, which is
never healthy. Evidence of housing market weakness continues to pour in
with pending home sales dropping 3.2 percent in the month of April.
Inflationary indicators were slightly softer with the PCE core deflator
and prices paid falling short of expectations. The bottom line is that
the Federal Reserve will continue to stand pat for the remainder of the
year. Ten year bond yields rose to 4.95 percent, the highest since
August 2006. With the stock market hitting another record high, the Fed
will not want to risk creating a bubble by lowering interest rates
prematurely. Steady rates benefits USD/JPY but has no immediate impact
on the EUR/USD since traders of that pair are focused on next weeks
ECB rate decision. The economic calendar is relatively light for the
US, but the data that is due for release are important. We are
expecting factory orders, service sector ISM, and the trade balance.
Federal Reserve Chairman Ben Bernanke will also be speaking on the hot
topic of housing and the economy.

Euro: ECB Expected to Raise Rates Next Week

The Euro held up very well despite the stronger US ISM and non-farm
payrolls figures. This strength was partially due to robust German
retail sales in the month of April which tripled expectations. The
market is looking at this number as a validation of a need for further
rate hikes next week. ECB President Trichet said this morning that
second round inflation effects must be avoided. This language suggests
that a hawkish stance after June is not out of the question. What
happens after June is will be everyones focus next Wednesday. The
central bank has provided little clues on where they stand and data has
been mixed. For example even though we had solid spending numbers from
Germany this morning and a lower unemployment rate for the region as a
whole, manufacturing PMI was softer that expected. Data earlier in the
week could help to clear the air a bit with Germany factor orders,
Eurozone service sector PMI and producer prices due for release.
Meanwhile Swiss data fell short of expectations today with Swiss PMI
slipping from 61.9 to 58.9. It seems that even though the franc has
remained weak, Swiss businesses are actually less optimistic about
business activity. The current account surplus edged higher while
consumer prices were right in line with expectations. Unemployment is
the only release on the calendar next week.

British Pound: Bank of England Meeting Expected to be a Nonevent

Like the Euro, the British pound held up very well against the US
dollar today. In fact, the currency is up across the board thanks to
the highest manufacturing PMI reading in 8 months. Both input and
output prices increased, which is reflective of the higher prices
charged by businesses. Although the UK economic calendar was relatively
light this past week, it picks up in the week ahead. We are expecting
construction sector PMI, retail sales, service sector PMI, more house
price reports, industrial production and another Bank of England rate
decision. Unlike the ECB, where the rate decision is expected to be a
big market mover regardless of which way the central bank sways, the BoE
rate decision will most likely be a nonevent. Having just raised rates
last month, even though the central bank could still raise rates again
in the months to come, mixed data will prevent them from lifting rates
in June. When the BoE leaves rates unchanged, they do not issue any
comments or statement, which is why there could be little reaction to
the rate announcement.

Japanese Yen Crosses Hit Fresh Decade Highs

One look at the Dow and it is not hard to guess how the Japanese Yen
behaved over the past 24 hours. Another record high in the US stock
market has sent the yen tumbling once again. Carry trades have
continued to perform well with AUD/JPY hitting a fresh 15 year high,
NZD/JPY a 17 year high, CAD/JPY a 15 year high and GBP/JPY a 9 year
high. As we have said often, the carry will die only when the Dow dies
and at this point, the Dow remains strong. The Chinese stock markets
are also continuing to rebound, which raises the risk of another policy
change by the Chinese government over the next few weeks. Unlike the
rest of the world, there is barely any data of consequence in Japan, so
expect stocks to continue to drive the currencys performance.

Strong Performance Seen across all Commodity Currencies

The commodity currencies continued to perform extraordinary well today.
The Canadian dollar hit a fresh multi-decade high against the US dollar
after Canadian Prime Minister said that it would be a “huge mistake”
to interfere with the appreciation of the Canadian dollar. This clearly
indicates that the government has no plans to intervene in the currency
pair. In fact, parity is now the main target for USD/CAD traders and
pretty soon we could actually be there. IVEY PMI, unemployment and
trade are due for release next week, all of which are potentially market
moving Canadian data. Australia reported very strong manufacturing PMI
overnight, which is contributing to the overall strength in both the
Aussie and Kiwi. The central banks of both Australia and New Zealand
have rate decisions due next week along with Australian unemployment and
GDP.


DailyFX Research Team
Forex Capital Markets LLC
32 Old Slip, 10th Floor
New York, NY 10004
Tel (212) 897-7660
Fax (212) 897-7669
E-mail: research@dailyfx.com


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