The US labor market will become the main driver of US dollar price action starting Wednesday and leading up to Friday’s key non-farm payrolls (NFP) report.

Tuesday was a mixed day for the US dollar (USD), which held steady against the euro (EUR) and British pound (GBP) but traded higher against the Japanese yen (JPY) and all three commodity dollars.

The lack of continuation in Monday's selloff and the rebound off intraday lows in US equities signal that investors are trying to remain optimistic ahead of Friday's non-farm payrolls (NFP) report.

If the market took Monday's sharp decline in the ISM manufacturing index as a sign of wider trouble for the US economy, the dollar would have extended its slide. However, with Federal Reserve Presidents singing the praises of the US recovery, investors are holding out hope that the 12 Fed districts will report more improvements and non-farm payrolls will surprise to the upside.

The focus of the FX market will begin to shift to the labor market on Wednesday with the release of the ADP employment change, non-manufacturing ISM, and the Fed’s Beige Book report. The employment component of service sector ISM has a very strong correlation with non-farm payrolls and will therefore be the number to watch.

Overall, jobless claims have been very low, which suggests that the labor market continues to recover, but fewer firings do not always equate to stronger hiring. Still, even Federal Open Market Committee (FOMC) dove Sarah Bloom Raskin feels there has been much more progress in the economic recovery, and her optimism may be reflected in the Beige Book. If so, the dollar could extend its recovery.

At the same time, FOMC voter Esther George, who is a noted hawk, was a bit more direct. While she didn't give an actual speech because she fell ill, a prepared statement was released in which she called on the Fed to reduce its pace of quantitative easing (QE).

The supporters for tapering QE are adding up, and as long as Friday's NFP report isn't terrible, the Fed should remain on track to reduce asset purchases this year.

See related: 5 US Dollar Catalysts Still Upcoming

USD/JPY Gravitates Back to 100

For most of the Tuesday North American trading session, USDJPY flirted with the 100 level. The currency pair rose as high as 100.44, but the decline in US stocks drove it back down to the key level.

No Japanese economic reports are expected over the next 24 hours, but that does not mean that it will be a quiet Tokyo session. Recent yen volatility has been driven by big moves in the Nikkei and Japanese government bonds (JGBs), and the Bank of Japan (BoJ) is watching the volatility in the equity and bond markets very carefully. If these moves do not settle soon, they could increase the frequency of bonds purchased later this month.

2 Potential Catalysts for a Euro Breakout

With no major Eurozone economic reports released, the euro ended Tuesday unchanged against the US dollar. Producer prices dropped 0.2% in the month of April, which is not a big surprise considering that inflationary pressures around the world remain muted.

For the European Central Bank (ECB), the current inflationary environment is conducive to additional easing, and while they have said they are prepared to further stimulate the economy, the bar to do so should be high especially after the recent upward revisions to PMI.

Final service sector data is scheduled for release on Wednesday along with Eurozone GDP and retail sales, but none of these reports will affect the central bank's tone on Thursday.

For the time being, 1.31 seems to be tough resistance for EURUSD, which is coincidently trapped between the 100- and 200-day simple moving averages (SMAs). A breakout is imminent, but a big event risk like the ECB meeting or NFP report is needed to drive the currency pair out of its recent consolidation.

See also: 2 Potential Game-Changers for EUR/USD

The 2 Most Volatile Major Currencies

The Australian dollar (AUD) and New Zealand dollar (NZD) were not only Tuesday's biggest losers, but have also been the biggest movers among the majors over the past few trading days. Don't expect the volatility to settle anytime soon, either, as we still have Australian PMI services, first-quarter GDP, and trade numbers scheduled for release.

The data will need to be very good to offset the pessimism created by the Reserve Bank of Australia (RBA) and its dovish monetary policy stance. Despite a more than 8% drop in the currency's value, the RBA is either not yet satisfied with the depreciation, or wants to hold onto it as much as possible by not saying anything that could threaten the AUD decline.

Meanwhile, USDCAD held on to its gains, and weaker-than-expected Canadian trade numbers had very little impact on the loonie.

New Causes for GBP Optimism

Compared to many of the other major currencies, there was very little volatility in the British pound (GBP). Sterling ended Tuesday slightly lower against the US dollar and euro despite better-than-expected economic data.

After contracting for six straight months, the construction sector finally returned to expansion, and increased activity in the housing market is helping to support building activity. This follows a similarly encouraging increase in manufacturing activity last month, and if Wednesday's PMI services index also surprises to the upside, the Bank of England (BoE) will be able to rest easier for another month.

While the minutes from the last central bank meeting showed policymakers still worried about the outlook for the UK economy, given the latest economic reports, they will be in no rush to ease when they convene this week. In fact, when the minutes from this meeting are released, we expect there to be a twinge of optimism.

By Kathy Lien of BK Asset Management

DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.
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