[LFX]

Friday's payroll numbers were a perspective-changing positive surprise. Only once every couple of years are the headline, revisions, household unemployment and unemployment rate surprises so coherent in a single direction, so the effect goes well beyond that of normal surprises. It is clear that dollar shorts are now hedging or outright closing positions simply because the driver of FX seems to be shifting from the risk-on, risk-off trade (which led to the high degree of correlation with equity prices) to a more conventional correlation with interest rate moves/differentials. Moreover, the potential shift in drivers is even more pronounced – in recent months, the main USD correlation with rates (other than versus JPY) has been that rate differentials have mattered less than the overall direction of rates. Initially, USD was sold when rate expectations rose because that corresponded with greater optimism. Subsequently, it was sold on lower rates, as those corresponded to ongoing liquidity provision. Now, even though rates globally are moving together so shifts in differentials are modest, the fact that the driver is the expectation of Fed policy has made higher US rates a clear USD plus.

Looking ahead, see the following questions:

1) Does one swallow make a Spring? Last month's release was almost as disappointing as this one was positive, so there is a risk that this turns out to be an aberration. Key to watch is this week's retail sales release on Friday – the consensus is expecting modest gains. Perspective could change quickly if there is a truly negative surprise, although a positive surprise would probably have as much a reaction for confirming the strong payroll outcome.

2) What does the Fed think? Fed Chairman Bernanke (12:00 EST) and FRBNY's Dudley (17:45) speeches will be closely watched for the degree of buy-in into Friday's data. The question is how much are they committed to erring on the side of providing excess stimulus – if it looks as if the Fed is confident enough to pull back slightly.

3) Does the Fed care about the risk trade? So far risk trades are not nearly as chuffed about the payrolls release as was the bond market. Oil and non-oil commodity prices are down, which is probably a positive outcome from the viewpoint of the US's global trading partners. If equity markets decide that good news will do more damage through the discount factor than benefit through the top line, will the Fed be indifferent or does it think that the risk positive trade is essential to recovery because of the link to asset market health?

4) Is the fiscal impact the real game changer? If it looks as if fiscal outcomes will be better than expected (and if the gains are not offset by further spending programs), will the US policy framework return to the orthodox fold? Will the USD become welcome globally because the policy risk premium is reduced?

Because of this uncertainty, it is likely that we will see more position squaring than long USD positions until it becomes clear whether the positive outcomes will continue and what the Fed's policy response will be.