Friday's NFP report came in better than expected - 175K new jobs in May - although there was a reduction in the April number. U.S. equity markets were impressed, and the Dow closed over 200 higher. The theory that good employment news would cause the Fed to come closer to the day when they would taper off the size of their bond purchases, and thereby cause equities to sell off, was flawed today.
The bond market had a different take on the number, tacking on ten basis points to a 2.17 yield on the 10-year. The unemployment rate was a tick higher, 7.6% caused by a minor increase in the participation rate to 63.4%. The report gave ambivalent information. While the total unemployment rate went up, the U-6 unemployment rate went down to 13.8%. Manufacturing jobs were reduced by 8K jobs and there was a drop in average hourly earnings.
While the pundits were busy using the report as a reason equities were higher and the bond yield was going up, the forex markets seemed largely unaffected by the report. Perhaps this is the result of active forex markets earlier in the week. Thursday was a big day in euro futures trading at the CME. The total trade was almost 500K contracts for the day, twice the open interest of only 251K. For those unfamiliar with size of this trade, it goes like this: The euro contract is 125,000 euro which, if valued at 1.32 to the USD, amounts to a euro contract worth about $165,000. The 500K contract trade means the euro trade was over $80B for the day.
Open interest, surprisingly, went up 12.7K contracts. We know from last week's COT report that specs were short almost 110K euro contracts. Thursday was a strong trading day for the euro running up 200 pips to the topside of 1.33. I thought the rally was a short squeeze, but the increase in the OI tells us there was new buying and selling. This week's COT report showed specs, while still short, cut their size to 74.6K.
A weekly close in the EURUSD above the 1.32 handle is the highest close since early February. A weekly close in the EURUSD above the 1.32 handle is the highest close since early February. There is nothing in interest rate differentials to suggest an elevated euro value. Comparing ten-year bond rates, the U.S. yield 2.17 compared to Germany 1.54%, Britain 2.07%, and France 2.12%. If we continue and compare unemployment rates, or the respective economies growth rates, these, likewise, do not give us a reason for the euro's strength.
The question here is: do we respect the market's strength, or do we look for a spot to sell the euro? My inclination is to wait patiently on the sidelines for a spot to sell. If, on the rally-- which began under 1.29-- we then trade above the the 1.33 handle, there should be more short covering. Selling the EURUSD above the 1.34 area looks interesting.
Part of the answer has to be in the positioning of the specs long in the USD. Last week, the COT report showed a total USD long position held by the specs had reached a record of 540,479 contracts. The biggest long USD position was against the yen, 119.1K, but down from 136.2 in the previous report. Disappointed with PM Abe's new plans, shorts in the yen turned buyers and turned the yen up versus the USD. Two weeks ago, the USD bought 103 yen, and at one time on Friday it bought only 95 yen. It looks like some yen sellers have returned as we gone back to trade at 97.40.
Specs have been quite short the yen for weeks. The quick recovery of the USDJPY (NYSEARCA:FXY) off the bottom makes you wonder who is buying.
PM Abe did have some additional plans for economic recovery. On Friday, he told NIKKEI.com:
"Stirring capital spending and the renewal of factories and businesses is an urgent challenge," Abe said, adding that his government will discuss tax measures targeted at firms pursuing these ends........
Around that time, the government will propose competitiveness legislation seeking to encourage firms to invest and reorganize. The bill is expected to include tax incentives for companies that scrap old capacity in favor of new energy-saving equipment."
Should Abe's plans successfully revitalize the moribund Japanese economy, this might prove bearish on USD versus the yen. On Monday, we get the Japanese Q/Q GDP report. This is supposed to show the economy grew at a positive 0.9%, compared to 0% in the previous quarter. A good number might be attributed to Abe's plans, but would that not be friendly to the yen?
The big risk with the Abe plan is the rate on Japanese Government bonds increasing. The rate on the ten year is up to .85, but still a discount to other developed countries. If the global rates continue to climb, Japan is at risk, and the yen would weaken.
The trade in the British pound has been interesting this week. Bloomberg reports:
"The pound had its biggest weekly gain versus the dollar in more than three years as U.K. manufacturing, services and home-price data beat economist forecasts, boosting confidence in the economy. "
The rally in the pound carried from 1.52 to a high of 1.5680, easing back to settle at 1.5555. On Tuesday, we get the UK Manufacturing Report, followed by unemployment numbers on Wednesday. Should either of these numbers be friendly, some of the very large number of spec shorts will likely cover. They are short 101.2K, up from 98.4 last week. This might be a set up for a rally to the 1.58 level.
As always, mind your money.