Dollar down but not out after modest payrolls
By David McMahon
NEW YORK (Reuters) - Traders dropped the dollar to one-month lows against the euro and yen after a surprisingly weak U.S. jobs report on Friday -- but anybody expecting this to be a knockout blow for the currency may be disappointed.
To be sure, Friday's payrolls report for June showed the world's biggest economy created fewer jobs than expected for a third straight month, news that should undermine the dollar. But it also showed a sharp rise in average hourly earnings, highlighting a buildup in inflationary pressures.
A modest uptick in prices could give the Fed reason to raise rates further, extending its two-year monetary tightening campaign and supporting the currency.
Moreover, the dollar's sharp fall Friday was somewhat exaggerated, since market players were wrongfooted ahead of the jobs data by an overly optimistic forecast by check processor ADP, which estimated a rise of 368,000 jobs, twice the market consensus of 185,000. The actual figure was even lower, at 121,000.
"Clearly, the dollar was set up for a disappointment," said John McCarthy, director of foreign-exchange trading in New York at ING Capital Markets. "This data alone is not going to be enough to break us out of the recent trading ranges, or push us near the big target for euro-dollar, which is $1.30."
With another monthly jobs report, a raft of inflation data and semiannual Congressional testimony from Fed Chairman Ben Bernanke all due before the August meeting, some traders are wary of writing off the dollar just yet.
Fed funds futures showed that the market was now figuring on that there is a 62 percent chance of another Fed rate hike in August, down from roughly 70 percent before the jobs report.
The dollar fell more than 1 percent to just below 114 yen after the report on Friday. The euro was up 0.3 percent to $1.2820 as of mid afternoon New York trade, after earlier touching a peak of $1.2865.
Still, many analysts expect the dollar to fall in the latter half of the year as the Fed's tightening cycle draws to a close just as the European Central Bank raises rates, and even the Bank of Japan looks set to tighten.
Many are confident the euro will grind higher, especially given recent hawkish comments from ECB officials, cementing expectations for a rate increase in August, and maybe beyond.
"You've got the ECB showing signs of hiking rates aggressively, while the Fed is straddling the fence, and rates in Japan are still zero," says Michael Woolfolk, senior currency strategist at Bank of New York. "I think the euro will be the gainer out of all of this."
But many traders say that the dollar will not enter a broad-based decline until Asian currencies such as the yen start to rise significantly. The dollar has fallen more than 7 percent against the euro, sterling and Swiss franc this year, but has declined just 3 percent against the yen.
The yen, which most analysts see as the most undervalued major currency, may gain next week when market watchers expect the BOJ to raise interest rates by a quarter percentage point in its first rate hike in six years. But the BOJ has signaled that any rises will be modest and at a gentle pace.
In contrast, some analysts still see the Fed raising rates to as high as 6 percent by early next year, which would preserve the dollar's hefty yield advantage and likely keep tempting Japanese investors to sell their yen.
While a sustained rise in inflation would likely hurt the dollar, which most analysts expect to end the year lower against major currencies, further rate rises by the Fed to nip inflation in the bud could support the currency in the near term.
With a rise in average U.S. hourly earnings of 3.9 percent in June from a year earlier, the biggest gain in five years, the Fed is likely to remain vigilant.