US Labor Day:  One of the most critical points in the FX year

A look at markets past shows that the Labor Day week is one of the most critical weeks of the year. This article looks at Labor Day week for the last ten years and how EURUSD traded before and after.

The US Labor Day holiday is seasonally important, probably the most important date on the market calendar together with January 1. That’s because it effectively marks the end of the summer, not only in the US, of course, but also in Europe, where the holiday effect is even more pronounced. It is thus the beginning of the end of the year, when volatility often picks up and markets get back down to business. Inspired by the season, and particularly as we look ahead at key events in the pipeline after a period in which we reached new post-GFC lows in volatility/highs in complacency, I decided to take a trip down memory lane, looking at the past 10 years of Labor Day.

Labor Day 2011 – Locally pivotal

Conditions in 2011 could hardly have been more different from this year, as markets were in turmoil after a massively volatile August – the most volatile month for markets since the global financial crisis. EURUSD dropped quite heavily on Labor Day itself and the day after to close the day right on 1.40 and just below the 200-day moving average. This set the tone for further declines to sub 1.3200 levels by the 1st of October as risk appetite. AUDUSD suffered even steeper declines, though its behaviour around Labor Day was more muted. Note on the chart below how the top of the range of Labor day week was also the critical year after the squeeze into the late October summit.

Labor Day 2010 – The week after QE2 hint
Labor Day 2010 came just a week after the most famous of Jackson Hole conferences, at which Bernanke hinted at the upcoming launch of QE2. Labor day itself was the usual snooze-fest for currency markets, while Labor Day+1 saw the USD slightly stronger and risk appetite easing back after sharp post-Jackson Hole gains. (EURUSD dipped sharply on the day while AUDUSD and the stock market were far more steady). Since that day, however, the USD sold off mercilessly until the following May. The USD has never re-attained the level it traded at on Labor Day +1 of 2010 (against the G-10 currencies as a basket.)

Labor Day 2009 – touching off a EURUSD rally
EURUSD broke higher from the August high on Labor Day +1 and rallied from 1.4400 to 1.5100 by late November (as the EU crisis was to appear on the radar screen). The previous Friday before Labor Day closed with a break to a new high in AUDUSD after a range-bound August, and the pair never looked back in its rally from 0.8500 to as high as 0.9400 by mid- November. Equity markets also advanced higher, though with deeper backfilling.

Labor Day 2008 – Other fish to fry
The markets were already slanting into the global financial crisis and the Labor Day weekend didn’t figure in the scheme of things – the worst of the fireworks came after the mid-September Lehman bankruptcy. Point of interest: looking back at the charts, I was reminded of the huge, if brief, short covering rally after the initial Lehman-triggered sell-off (Sep. 15 was the date of Lehman declaring bankruptcy).

Labor Day 2007 – EURUSD launching pad
A very different time for markets – though hard to see that from the charts. Labor Day was usual boring affair, but Labor Day+1 saw EURUSD teasing a bit below short term support before recovering on the day and then launching a monster rally by the end of the week that saw the pair rally from 1.2600 to as high as almost 1.5000 in a nearly straight line by late November. Fed rate cut expectations in the sub-prime housing crisis had been brewing since mid-July and Bernanke cut 50 bps on September 18. A Fed rate-cut triggered equity market rally had petered out by mid-October. AUDUSD was in an interesting situation, as the August clear-out of over-positioned carry trades yielded to a sharp rally, though one that didn’t get started until in earnest until the day of the Fed cut.

Labor Day 2006 – Short term pivot – but with an echo.
Labor Day didn’t figure hugely in the equation for EURUSD, though it was the high in EURUSD for the next two months or so and the selling started on Labor Day +1. In risk-correlated markets, the equity market had broken above the range of the summer doldrums in the second half of August and the first week of September saw a brief consolidation before the market launched an incredibly persistent rally with almost no back-filling that lasted until the following February.
AUDUSD developed somewhat differently. There had been a clear-out in emerging market longs during the early summer of 2006 and commodities suffered in August and especially through September. AUDUSD topped out on Labor Day and Labor Day+1 after trying at August highs and then sold off until early October before recovering in line with risk appetite. Note in the EURUSD chart below that once the zone defined by Labor Day week was broken on the upside in late November, it practically exploded higher.

Labor Day 2005 – Pivotal and touches off a USD rally
Besides 2008, 2005 was the only consistently good year for the USD in the last 10 years (it was also the year of HIA – the Homeland Investment Act that saw hundreds of billions of USD in corporate profits repatriated. Side note: there could be a reprise of this legislation next year. The week of Labor Day proved pivotal once again – as EURUSD topped out the Friday before Labor Day just above the summer range. Then Labor Day+1 saw a sell-off that was the beginning of a decline that took the pair from the 1.25+ area all the way to below 1.20 by the end of the month and 1.1650 by late November. Equities and AUDUSD rallied a bit on Labor Day week, but this yielded to downside through mid-November in AUDUSD, while equities began recovering in late October.

Labor Day Week 2004 – Labor Day week marked USD top for rest of the year
This was just ahead of what looked like it would be a very close US election the markets had been on hold all summer. The trading around Labor Day itself was not exceptions, though the USD never traded stronger than Labor Day week and collapsed into the end of the year, accelerating a few weeks ahead of the election.

Labor Day Week 2003 – Massive USD pivot from strength to weakness
A pivotal week for the USD in 2003 as the markets were trying to decide if the US economic recovery was for real (surveys were recovering, but some were still a bit low and the unemployment rate peaked in July of that year). The USD was rallying impressively in the summer, consolidating losses from earlier in the year. The week of Labor Day was the crucial pivot point. The USD topped out on Labor Day+2 and then dropped in a nearly straight line through the end of the year.

Labor Day Week 2002 – Not interesting at first glance but….
The Labor Day week didn’t figure much for EUUSD or equity markets, but it did see a low in AUDUSD that has never been taken out since then (AUDUSD traded at 0.5400 that week.).

And what about Labor Day Week present- 2012?

It would seem that the markets are trying to play the current Labor Day/return from summer somewhat in line with Labor Day 2010, reading the tea leaves of Bernanke’s rhetoric last Friday as pointing toward a fresh round of QE. But there are two glaring differences this time around. First, if QE is mostly in the anticipation rather than in the reality, then this round is the extremely well anticipated and volatility is extremely low. In 2010 (and even more so in 2011) the markets were still in a soft patch at this time of year and sentiment was poor (the VIX was at 27 vs. the current 17 – in 2011 it was 33). Second, we’ve got a presidential election and the questions about the fiscal cliff in the pipeline.

Labor Day and Labor Day+1 may not offer any kind of signal, but considering the key events in the pipeline over the next couple of weeks and considering the season, it wouldn’t be surprising to see this week and next as a key pivot area for the rest of the year – something that this time frame has often been in years past, as I hope the examples above have shown.

On the chart below, I suggest two possible scenarios – the green one in which this week proves an important pivot point for this rally of consolidation and the EURUSD never looks back as it resumes the sell-off. The other scenario is one in which the coming two weeks generates a positive response to the EU and ECB efforts and to the Fed’s likely QE3 in the pipeline. This rally eventually fades further out in the fall and once the current area is taken out on the resuming sell-off, the selling really begins in earnest.

Be careful out there.
John