ADP and ISM data misses deal mild blow to USD

By Kathleen Brooks, Research Director UK EMEA FOREX.com

The problem with this US recovery and stock market rally is that no sooner are you lulled into a false sense of security that the economic recovery will continue then a data point reminds you that the US recovery is still fragile. Take today's ADP report, it missed expectations of a healthy 200k and came in at 158k for March. This is still a good run-of-the-mill number, but it's not the magic 200k that everyone is watching for as we head up to payrolls on Friday. While the headline number was fairly healthy, there were a couple of details worth looking at in more detail. The private construction sector created no new jobs last month, according to ADP, while manufacturing and finance only created 15,000 jobs. The service sector, particularly professional and business services, created the bulk of jobs.

This report contains both good and bad news. It is good that professional service companies continue to hire, as these can be fairly well paid, thus boosting consumption. However, this recovery has grabbed peoples' attention because of the pick-up in housing. In fact, US house prices increased by more than 8% in the year to January, the fastest pace of increase since 2006. Rising house prices are important for a few reasons: 1, it helps to boost confidence and the wealth effect that can help support consumer spending, 2, it boosts the house building industry and can help create much-needed construction jobs. Thus, the fact no jobs were created in this sector last month is worth watching carefully.

Watch construction in this week's NFP

The ADP has a patchy relationship with Payrolls, and Friday's NFP number is the main event, but the ADP has definitely focused attention on construction as we lead up to Friday's all important report. Right now the market is expecting non-farm payrolls to increase by 205k for March. I feel that if we get below 200k this could be the canary in the coal mine for stock markets...

The market has basically ignored the ADP result; however the miss on the ISM non-manufacturing survey for March dealt a mild blow to USD. This index dropped back to 54.4 from 56.0 in Feb. The detail in the report was also weak, with the new orders, export orders and employment sub-indices all registering weakness. Although 54.4 is respectable, it doesn't suggest that the US economy is having a stellar recovery, more of a steady recovery.

Worrying signs (again) for US stock markets

US stocks markets have opened fairly flat to slightly lower today after the ADP and ISM data misses, but we have highlighted some worrying signs that could disrupt this rally: some of the lead indicators are weak including small cap stocks and the Dow Transports sector, which are both economically sensitive indicators. Added to that, the rally yesterday has been led by defensive stocks, which typically suggests that investors are getting worried about a sell off. Thus, economic data in the next couple of days will be the key short term driver for markets and so far it is not looking good.

The UK and Europe have been fairly quiet today after yesterday's data dump. The biggest news is that the pound has managed to find a base around 1.5070 after yesterday's sharp selloff. 1.5150 has capped gains so far today. The Bank of England Q1 lending report contained mixed messages: on the positive side it said that the mortgage market should improve substantially this quarter, but on the downside it said that lending to SME's was basically unchanged in Q1. This is not market moving stuff, but it is mildly supportive of more QE at this week's BOE meeting, which is pound negative.

ECB could weaken collateral standards again ...

The ECB is also concerned about SME's according to the German press. Apparently the ECB board members are mulling a plan to lower banks' collateral requirements at this week's meeting to include loans to SME's in return for cheap cash from the ECB. This could be announced at tomorrow's press conference. The ECB is very limited in what it can do. We doubt it will announce a rate cut (usually it signals those in advance), it already has the OMT, and banks are paying back LTRO loans. Thus, sacrificing the quality of its balance sheet is about the only weapon left in its store.

One thing is for sure, lending, especially in the South, remains extremely constrained and is thwarting growth in places like Spain, Italy etc. So loosening the credit channels to small and medium-sized businesses is important. However, the ECB's effectiveness could be thwarted if banks start to hoard capital on the back of the "bail-in" for Cyprus, especially in Spain where its banking sector's woes are well known.

Overall, the EUR is in recovery mode today after falling back below 1.27 yesterday. The key driver for the euro will be the ECB meeting. A less dovish than expected Draghi could cause a short term rally, but overall we think any strength will be sold into. We have heard that some selling interest is gathering around 1.29. 1.2750 then 1.2660 (the lows from November) are key support zones.

Our one to watch: USDCHF

After breaking above 0.9500 earlier, this cross fell back to support at 0.9450 at the time of writing. This cross is on our watch list as we believe that a broad based dollar renaissance will need to include a move higher in the USDCHF. It's easy for the dollar to outperformer weak currencies like the EUR and GBP, but if the bull case for the greenback is to hold water then we need to see the USD outperform Europe's strongest currencies and strongest economies, like Switzerland. This isn't a trade recommendation, as such, more of something to keep on the radar. But if USDCHF can manage a daily close above 0.9555 then it opens the way for a move to 0.9660 ? the highs from August 2012.

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