• U.S. Dollar Faces its First Test
  • Breakouts in USD/JPY and EUR/JPY
  • EUR Breaks 1.30 as Aid Payment to Greece Under Threat
  • GBP - Construction Sector Expands Alongside Manufacturing
  • AUD - Another Night of Busy Australian and Chinese Data
  • CAD - Oil Closes in on $100
  • NZD - Watch Out for Chinese PMI

U.S. Dollar Faces its First Test

With 3 more days to go before the pivotal U.S. non-farm payrolls report, the dollar extended its gains against all of the major currencies. Milestones were reached in some pairs while others broke key levels. The sustainability of the dollar's rally has been nothing short of impressive but it should not surprise investors since the strongest moves in the FX market are the ones supported by fundamental drivers. In this case the Federal Reserve is getting ready to reduce the amount of stimulus that it provides to the economy and investors are just looking for economic data to confirm that the economy is ready for tapering.

The dollar faces its first test tomorrow with a number of U.S. economic reports on the calendar that will help shape expectations for Friday's release. The day starts off with a layoff report from Challenger Grey & Christmas that will be followed by the ADP Employment Change, jobless claims and most importantly, the ISM non-manufacturing index. Earlier this week we learned that the manufacturing sector lost jobs for the first time since 2009 and now the question is whether the service sector suffered the same fate. We don't think that it did because otherwise the Fed would not have lowered its unemployment rate forecasts but there's always the risk the data could surprise to the downside. Layoffs are expected to decline and most likely ADP will report an increase in U.S. payrolls.

For the U.S. dollar to hold onto its gains, all that is needed is for these releases to meet expectations but in order for USD/JPY to break 101 and the EUR/USD to drop through 1.2950, an improvement needs to be seen in both the headline ISM non-manufacturing index and the employment component of that report. If service sector activity slows or worse, employment conditions contract, the dollar could give up its gains quickly as investors reset their expectations and reduce long dollar positions ahead of the non-farm payrolls report. Last month, the employment component of this report dropped from 52 to 50.1, a hair above the 50 line dividing expansion from contraction. Therefore a decline in this index would most likely mean job losses in the month of June, which would not be good for the dollar. Considering that many U.S. investors and traders will be taking a long weekend beginning noon time tomorrow, if the data misses expectations, we could see a heavy reversal of dollar long positions as investors square up for the July 4th holiday.

Breakouts in USD/JPY and EUR/JPY

The weakness of the Japanese Yen and more specifically the strength of the U.S. dollar drove USD/JPY and EUR/JPY above key levels. EUR/JPY was the first one to gain momentum, taking out 130 and then 131 during the North American session. USD/JPY broke 100 shortly after the NY open and extended to a high of 100.72 before settling slightly lower at the end of the day. The 1.78% rally in the Nikkei overnight helped to keep both currency pairs bid throughout the day. Since dropping to a low of 12,445 on June 13th, Japanese stocks rebounded more than 13%. USD/JPY has a positive correlation with the Nikkei and its recovery contributed to the currency pair's rise. The next level of resistance in USD/JPY is at 102.50, an area where the currency pair struggled to break in late May. For EUR/JPY, resistance is at the June high of 131.40. There were no major economic reports from Japan last night. Labor cash earnings was probably the most important release and unfortunately earnings continued to stagnate in May, a sign of the uphill battle that the Japanese government faces to stimulate growth after the Lost Decade. With no economic reports on the calendar this evening in Japan, the outlook for USD/JPY and EUR/JPY will hinge on the performance of the Nikkei and Wednesday's U.S. economic reports.

EUR Breaks 1.30 as Aid Payment to Greece Under Threat

The euro was trading heavy throughout the European and North American sessions but it took the sell-off in U.S. stocks to drive the currency pair to its lowest level since June 3rd. The 1.30 level has finally been broken in a meaningful way and we have to admit that we didn't expect it to happen on this light data day. Nonetheless, investors are beginning to position for the strong possibility of dovish comments from the ECB Thursday and a positive U.S. non-farm payrolls report on Friday. Eurozone economic data missed expectations but the pressure out of Europe came primarily from German Chancellor Merkel's warning that the next aid payment to Greece could be delayed. The Eurozone has given Greece 3 days to "deliver on the conditions attached to its international bailout" or risk not receiving their next tranche of aid. This warning goes hand in hand with a similar warning from the IMF last month - it seems that Europe's sovereign debt troubles are slowly returning. Meanwhile inflationary pressures in the Eurozone continue to subside with PPI dropping 0.3% in the month of May. Softer price pressures give the ECB a stronger reason to keep monetary policy ultraeasy. Final Eurozone PMI Services numbers are scheduled for release tomorrow along with retail sales.

GBP - Construction Sector Expands Alongside Manufacturing

Like many of the other major currencies, the British pound weakened against the U.S. dollar but strengthened against the euro. A survey by Markit Economics and the Chartered Institute of Purchasing and Supply revealed that UK construction rose for the second consecutive month in a row to 51.0. The major contributor for growth was the residential building sector, where activity increased for five consecutive months thanks to to the Funding for Lending Scheme. CIPS said, "Housing is the leading light sustaining last month's performance, meanwhile commercial and civil engineering activity stabilized, arrested months of decline giving further cause for optimism." The survey also revealed that builder confidence rose to the highest level in more than a year in June, with the number of people who see a rally trumping those who anticipate a decline in activity throughout the year. The index hovered around 50 which separate growth from contraction. CIPS said, "A new dawn is emerging in the construction industry, with confidence of a sustained recovery beginning to build thanks to two months of consecutive output growth and the pace of new orders expansion hitting a 13 month high." The PMI Services index is scheduled for release tomorrow and while economists are looking for slower growth, we feel there is scope for an upward surprise given the increase in manufacturing activity and improvement in consumer confidence last month.

AUD - Another Night of Busy Australian and Chinese Data

Broad based U.S. dollar strength and dovish comments from the RBA drove the Australian, New Zealand and Canadian sharply lower against the greenback. According to our colleague Boris Schlossberg, "the RBA maintained it dovish bias, stating that, "The Board also judged that the inflation outlook, as currently assessed, may provide some scope for further easing, should that be required to support demand," keeping open the prospect of further rate cuts. He also added that, "Australian monetary authorities also continued to jawbone the Aussie, noting that, "The Australian dollar has depreciated by around 10 per cent since early April, although it remains at a high level. It is possible that the exchange rate will depreciate further over time, which would help to foster a rebalancing of growth in the economy." In light of slower Chinese growth the RBA clearly does not want to risk reversing the downtrend in the AUD and threatening a key support for the economy. If tonight's economic reports show slower retail sales and service activity growth and/or a trade deficit, the AUD/USD could extend its slide below 91 cents. If the data shows that the recent weakness in the AUD lifted growth, then the deeply sold currency pair could enjoy a small relief rally. Meanwhile losses in the NZD matched that of the AUD as commodity prices in New Zealand plunge. There are no economic reports from New Zealand tonight but China's non-manufacturing index could affect how the currency pair trades. The Canadian dollar dropped to a 1 year low against the greenback but losses would have probably been steeper if not for the rise in oil prices, which is now within striking distance of 100. Canada has trade numbers scheduled for release tomorrow but this report could take a back seat to U.S. data and oil.

Source http://www.fxstreet.com/fundamental/analysis-reports/daily-fx-market-roundup/2013-07-02.html

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