If Non-Farm Payrolls disappoints, expect a sharp selloff

US Dollar

The dollar gave up some of its gains yesterday as
the Euro crawls its way back from the 1.1901 low hit yesterday. The move though
is hardly impressive with the currency pair up only 50 somewhat pips from
yesterday’s low, especially following today’s sharp disappointment in the ISM
non-manufacturing survey. The US service sector report plunged to the lowest
level since April 2003 with a corresponding fall in the employment component. As
we edge closer to Friday’s non-farm payrolls report, the disparity between what
the manufacturing and non-manufacturing sectors are signaling is making a
prediction for Friday’s report all that more difficult.

Today we published our non-farm payroll preview
on our homepage and as far we stand, the slide in confidence and drop in help
wanted ads suggest that the risk is to the downside. However the Challenger
group reported 71.8k layoffs in the month of September, which is not that much
higher than the 70.6k reported back in August. The report suggests that the
additional job loss from the hurricane was nominal. What we are sure of is that
the market will probably act more violently to a weaker number rather than a
stronger number. It should come as no surprise that speculators in the market
are extremely long dollars at this point.

The FXCM Speculative Sentiment index continues to
signal more losses in the EUR/USD (we will be publishing our regular weekly SSI
report tomorrow at 10:30am EDT). This means that there probably aren’t that many
buyers left in the market while adamant dollar bears could be waiting on the
sidelines for the momentum of a bad number to start snapping up the EUR/USD at a
bargain. So watch out, Friday could deliver some interesting price action.


The euro is bouncing against the dollar thanks to
strong numbers this morning. Retail trade increased 0.9% in the month of August
while the service sector PMI survey advanced from 53.3 to 54.7. Germany and
Italy both experienced improvements but France, the usual laggard, experience a
slowdown in growth. Overall though, good numbers in both the manufacturing and
non-manufacturing sectors with improvement in the employment component certainly
prove hopeful for the Eurozone economy. The weaker euro and falling oil prices
is providing a double stimulus for the region.

The European Central Bank is set to announce
another interest rate decision and although we expect no change in interest
rates, the recent data does supports their more hawkish stance. Politically,
without getting too excited because politics can change as regularly as the
direction of the wind, Schroeder and Merkel seemed to be making progress on
their coalition talks and are moving forward towards a coalition government with
power shared by both parties. This would be the first time since 1969 that the
two parties may be running the government together, which is actually quite
interesting because collaboration may be the answer to resolving policy
differences and allow the group as a whole to push through reforms. An agreement
is targeted to be reached by October 18th, the first day that the new parliament
will hold their session, which would also mark the end of Schroeder’s term.

British Pound

In contrast to the Eurozone, the UK’s service
sector PMI index fell in the month of September from 55.2 to 55.0 which is the
slowest pace of growth in nine months for a sector that accounts for close to 75
percent of the country’s economy. The reaction in the pound has been limited
with earlier losses quickly erased. All eyes will be turning to tomorrow’s Bank
of England rate decision. The central bank is expected to leave interest rates
unchanged at 4.50 percent after having cut them by a quarter of a point in
August. Although BoE officials have expressed concern about the downside risk to
growth they are not expected to move on rates again till next year since
inflation has been a major cause for concern, reaching 2.4 percent in August,
which is the highest pace of growth in eight years. Also, the impact of the
hurricane in US has already spread to companies abroad. British Petroleum
announced yesterday that the hurricane has wiped $700 million from third quarter
profits while British Airways announced today that they would not meet their
return on sales target because of high fuel prices.

Japanese Yen

The Japanese Yen is firmer against the dollar
today as we see some bulls take profit ahead of the 115 level, which is sure to
be a tough barrier to break. The slide in oil prices is being modestly positive
for the yen as optimism lingers following comments by Bank of Japan board member
Haru who suggested that interest rates could be increased in early 2006. However
the rally in the Japanese yen looks limited and could be easily erased tomorrow.
The dollar’s growing interest rate advantage over the Japanese yen seems to be
the predominant theme at this point with the market expecting two more rate
hikes this year. Therefore even if Japan does seriously consider raising
interest rates, it wont be till next year, which means that it will probably not
be a focus until after the market has completely priced in the end of the Fed’s
tightening cycle.

Kathy Lien

Kathy Lien is the Chief Currency Strategist at
Forex Capital Markets. Kathy is responsible for providing research and analysis
for DailyFX, including technical and fundamental research reports, market
commentaries and trading strategies. A seasoned FX analyst and trader, prior to
joining FXCM, Kathy was an Associate at JPMorgan Chase where she worked in Cross
Markets and Foreign Exchange Trading.

Kathy has vast experience within the interbank market using both technical and fundamental analysis to trade FX spot
and options. She also has experience trading a number of products outside of FX,
including interest rate derivatives, bonds, equities, and futures. She has a
Bachelors degree in Finance from New York University. Kathy has written for
Stocks and Commodities, CBS Market Watch, ActiveTrader, Futures and SFO
Magazine. She is frequently quoted on Bloomberg and Reuters and has taught
seminars across the country. She has also hosted trader chats on EliteTrader,
eSignal, and FXStreet, sharing her expertise in both technical and fundamental