Dollar Rallies after NFP - How Much Further Can it Rise?

Thursday, 03 July 2008 21:29:12 GMT

Non-farm payrolls were right in line with expectations, triggering a broad based dollar rally. Even though the US economy saw a net job loss for the sixth consecutive month, the sheer fact that non-farm payrolls was no where near -100k, was enough to drive the dollar higher (More details on Non-Farm Payrolls). According to the yield curve, traders now expect more aggressive tightening by the Federal Reserve than the ECB over the next 12 months. If inflation continues to trend higher, this is very possible since the Fed has more room to raise interest rates. The ECB’s disappointment and the market’s relief that NFPs were not as bad as they could be should lead to further dollar strength in the coming week. However the underlying weakness in the payrolls report and the sharp drop in service sector ISM indicate that the US economy is still on a downward spiral. Payrolls for the month of June was revised to more negative levels, while the unemployment rate remained unchanged at a 4 year high. With jobless claims topping 400k last week, the labor market will only get worse in the coming months. American Airlines announced today that 7,000 jobs will be cut by the end of 2008 to offset the pain of rising fuel prices. This follows the equally severe layoffs announcements that we have already heard from Starbucks, Citigroup and Goldman Sachs. The service sector is back in contractionary mode with the ISM index falling from 51.7 to 48.2. The employment component of the report fell to a record low, foreshadowing more problems in the labor market. Yet even as economists and analysts, (us included) are calling for doom and gloom, the numbers have yet to show it. Today’s NFP figures are not as bad as the market feared while consumer spending remains positive. Inflationary pressures on the other hand are continuing to rise. Oil prices hit a new record high above $145 a barrel. This will add further pressure to the prices paid component of service sector ISM, which already hit an 11 year high in the month of June. The US economy will worsen, but probably not as quickly as inflationary conditions. The rise in oil prices is testing the patience of the Federal Reserve. If they continue to remain on hold and fail to indicate when they plan on raising interest rates, the rally in the US dollar could be limited.