By DailyFX – Will Weak Payrolls and ISM this Force the Fed to Drop their Inflation Bias Next Week? Bad… … news begets bad news which begets even more bad news.

This is why both the US dollar and the Dow are lower in Friday trading. This
morning, we had much weaker than expected non-farm payrolls. Despite a
sharp rise in consumer confidence and a drop in average weekly jobless
claims, US corporations only added 92k jobs onto their payrolls, which
was the weakest level since February 2007 and the third weakest in 2
years. This brought the unemployment rate up to 4.6 percent, the
highest since September 2006 .

The divergence between jobless claims and non-farm payrolls
indicates that even though companies are not firing, they are also not
hiring. With hedge funds and mortgage lenders blowing up left and
right, August could be ugly for the labor market. American Home
Financial announced that they will be cutting their staff from 7000 to
750, which is a loss of 6250 jobs. We are sure that they are not the
only ones to be downsizing. In addition to American Home Financial’s
announcement and the bad non-farm payrolls number, Standard and Poor’s
also cut its outlook on Bear Stearns to negative while Wells Fargo
raised its mortgage rates on 30 year jumbo loans from 6 7/8 percent to 8
percent. The last piece of US data released today was service sector
ISM which dropped from 60.7 to 55.8. The fall in bond yields yesterday
was an accurate sign that we have yet to see the worst. Will there be
respite next week? Possibly – the economic calendar is very light and
the only piece of US data with any market moving potential is the
Federal Reserve’s monetary policy decision. Rates are expected to be
left unchanged, but as usual, the market will be focusing on the
accompanying statement. Will the recent movements in the stock market
and endless troubles in the US economy force the central bank to drop
their hawkish inflation bias? The potential exists, but based upon the
latest Fed rhetoric, they are not ready to do so.

Euro Benefits from Deteriorating US Outlook for US Economy
Yesterday, ECB President Trichet signaled to the markets that despite
the recent slowdown in European growth, they still have full intentions
of raising interest rates next month. This of course is bullish for the
Euro and helped to take the currency higher against the US dollar.
However the breakout in the Euro today was more a reflection of the
deteriorating conditions in the US economy than the more promising
outlook in the Eurozone. We are currently in an environment where the
Federal Reserve may have no choice but to slowly downgrade their degree
of hawkishness while the ECB is expected to deliver one and possibly
even two rate hikes by the end of the year. Although service sector ISM
in the Eurozone was stronger than expected in the month of July, but
retail sales for the region was weaker. Like the US, the economic
calendar is relatively light. German factory orders, industrial
production, the trade and current account balances are the only pieces
of data that are potentially market moving and even then, they are
second tier data. All of these reports reflect aspects of the Eurozone
economy that may be affected by the strength of the Euro. Therefore a
downside surprise is far more likely than an upside one. Meanwhile, the
Swiss franc rallied significantly today despite a drop in consumer
prices. With gold prices up sharply, this may reflect flight to safety.
Swiss unemployment and the SECO consumer climate reports are due for
release next week. Overall, the Swiss economy has been doing very well,
which is why we expect both reports to be firm.

British Pound Breaks 2.04, Quarterly Inflation Report Expected Next
Week
It has been a strong week for the British pound despite mixed economic
data. Even though activity in both the manufacturing and construction
sector accelerated in the month of July, service sector activity slowed.
All of these indices remain well above it comparative US levels, which
is the reason why the currency has outperformed the US dollar. The Bank
of England left interest rates unchanged, which made the rate decision a
non-event, but next week Central Bank Governor King will be delivering
their Quarterly Inflation Report. Based upon the price action in the
British pound, traders expect the central bank to remain hawkish and
signal the possibility of another rate hike this year. Although this is
the most likely scenario, when it comes to the Bank of England, always
be prepared for surprises since the UK is also being hit by the US
subprime problems. According to the Council of Mortgage Lenders,
foreclosures have hit an 8 year high.

Employment Reports Expected from Canada, Australia and New Zealand Next
Week
The Canadian, Australian and New Zealand dollars are slightly weaker
today. Canada released much softer than expected IVEY PMI. Analysts
were already looking for a 7 point drop, but instead, the index dropped
a whopping 13.2 points. This indicates that the strength of the loonie
is finally having a big impact on the Canadian economy. The drop in the
employment component of the report also suggests that next week’s
employment numbers will be weak. Australia and New Zealand will be
releasing their own employment reports as well. The employment
component of the stronger Australian service sector PMI suggests that
the labor should remain tight. The New Zealand labor market should also
hold steady.

Historical Movements of the Yen Crosses
Over the past week, the Japanese Yen crosses have moved in lockstep
with the Dow and today was no different. With the exception of EUR/JPY
and CHF/JPY, all of the other Yen crosses gave back its prior day’s
gains. The growing problems in the US continue to weigh heavily on the
market’s appetite for risk. Even though it may feel painful for carry
trades at the moment, the 3 percent that we have seen thus far is
marginal compared to how much carry trades have moved historically (
http://www.dailyfx.com/story/topheadline/Forex_Carry_Trade_Unwinds_Over_1186160383898.html
). There was not much Japanese Data to help the Yen this week but the
week ahead is more promising with a relatively busy Japanese calendar,
which includes the corporate goods price index.

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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