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After the storm that was unleashed by Friday’s employment reports, a sense of calm has settled over the financial markets this morning. After the United States released its weakest employment numbers in three years, investors now expect the Federal Reserve to tighten more slowly than previously estimated. Global equity bourses are nearing six year highs, while pressure has come off the emerging markets. Commodity prices are generally up, although crude oil is trading on a weaker bias.

A sharp decline in US yields has put the greenback on the defensive, propelling the yen to its largest gain in almost three months.  Softening economic data are pulling the pound sterling down against the euro, but both are up against the dollar as market reassess the Fed’s tightening path forward.  Investors still expect the central bank to wind its bond purchases down by the end of the year, but rate hikes are now forecast to begin in late 2015.

In contrast, the Canadian dollar is getting pummeled. The loonie is trading a feather away from the 1.10 mark after Friday’s spectacularly bad employment report. With 46,000 jobs lost in December and less than 100,000 net positions created over the course of the last year, the Canadian economy turned in its worst annual performance since 2009.  While it is still an extremist position, many traders are talking about the possibility of an interest rate cut from the Bank of Canada. As this concept gains broader acceptance, a break through the 1.12 mark is becoming increasingly likely.

Markets are now focused on  tomorrow’s  US retail sales report, with most observers expecting growth to slow after November’s 0.7% increase. To capitalize on this, many traders are taking short positions against the dollar, particularly in the options markets. The United States still appears to be the most competitive of the major economies,  with greater potential for outperformance against other large trading blocs – meaning that  few expect the currency’s weakness to be sustained in the longer run.

In sum, market participants should be prepared for a temporary dampening in the enthusiasm that has driven the US dollar higher over the past few months. Euro and sterling could challenge recent highs, and a short-term bounceback in the emerging markets is a strong possibility.

Canadian dollar traders face a more challenging outlook. The 1.10 mark remains the clear target for speculators, but a loss in momentum could spur a sharp short-covering rally – potentially providing dollar buyers with an opportunity to edge out of what has been an incredibly painful start to the year. That being said, we expect the currency to continue weakening as the world finally wakes up to the reality – the Canadian economy has relied upon domestic consumer spending for too long, and external competitiveness has plunged. The transition toward a more sustainable growth model will be long and difficult, but a weaker currency should be strongly supportive factor for the country’s exporters in the year ahead.

Have a great week, and please talk to your trading teams about strategy. As yield curves have changed and volatility has risen, pricing dynamics have changed across the forward and options markets, meaning that many instruments are now offering extremely attractive performance characteristics for those who are looking to harness upside while protecting against downside risk. Happy trading!

Further reading:

EUR/USD Jan. 13 – Steady After Recent Gains

GOLD: Faces Continued Corrective Recovery Risk