[AndrewWoo]

The stronger-than-expected employment report out of the US had a marked effect on Friday - but one that came as something of a change from the prior norm: strong US data was a USD positive. Is this likely to persist? Some have argued for that higher US bond yields, as long as they are associated with stronger growth rather than increasing worries about the US fiscal position and potential for the monetization of debt, were good for the USD. This is particularly the case for USD/JPY where the close relationship between the longer-term yield differential and the currency. The rise in yields appears to have been the main driver for the USD strength.

Will the change in relationship between the USD and US data persist? A lot depends on two factors: what is happening to other important prices and the FOMC meeting this week appears crucial. Importantly, last week saw the oil price moving sideways, including following the data. USD remains vulnerable to higher oil prices. The labour market data's strong effect may have been associated with the widely-held view that the Fed is not going to start tightening policy while the unemployment rate continues to climb. The combination of the unemployment rate being well below expectations (despite that being largely due to a reduction in the participation rate, normally viewed as a bad thing) and the next FOMC meeting was less than a week away may therefore explain some of the strength of the USD. If the FOMC remains dovish, it may prove temporary. However, the speed of both the US and global recoveries has been striking (see below). Given that, market economists expect no increase in asset purchases and a more upbeat tone on the economy. This would likely be a USD positive and may herald a period where positive news for US yields continues to be a USD positive as long as it is associated with stronger activity data and a muted response in commodity markets.

It's Over!

The lead article in the Global Economics Weekly, "It's over", calls the end of the global recession. The recovery is certainly mixed - for example Emerging Europe continues to lag the general improvement - but has clearly become more widespread over recent months.

How is this likely to affect FX markets? To some extent it is likely to lead to a continuation of recent trends - the "risky" currencies have outperformed over recent months and in general are likely to continue to do so. But positioning matters a lot. The CFTC data suggests that both AUD and CAD longs remain the largest in the FX world. Given improving prospects and especially the marked narrowing of spreads and better liquidity in FX markets suggests that the laggards of the recovery - especially the NOK and SEK - may have considerable upside from here. The JPY appears particularly vulnerable despite the stronger data overnight.

What about GBP following the BoE decision? The Inflation Report press conference on Wednesday will be crucial. Given the decision this may be fairly downbeat despite the improvement in forward-looking UK data. That would continue to suppress GBP strength. But GBP remains 20% weaker against the EUR than prior to the crisis, likely too much given the change in fundamentals.