Barring Upside Employment Surprise, Dollar May Fall

Highlights

The US dollar is mixed ahead of the monthly jobs data.   It is generally consolidating yesterday’s losses against the European currencies and Japanese yen, while slipping against the dollar-bloc.  The increased concerns about the trajectory of growth, especially in the US and China at the same time that successful bond auctions and refi operations in the euro zone generated a positive news stream providing fuel in recent days for a recovery in the euro and sterling that was already under way.  Meanwhile, the unwinding of risk-on trades and the narrowing of interest rate differentials helped underpin the yen.  At this juncture, it would seem to take a significant upside surprise in today’s US employment report to reverse the near-term trends.

Asian equities were mixed, though the MSCI Asia-Pacific Index was off about 0.4% to finish the week down 3.6%.  The Nikkei peaked out a little more than 0.1%, but Shanghai was up 0.4%.  The Taiex was the regional leader up a little more than 1% and Taiwanese financials led the way with a 3.4% rise.   The Hang Seng was the region’s biggest loser, dropping 1.1%, with basic materials and oil and gas posting outsized losses.  European bourses opened higher but have made little progress in either direction, perhaps awaiting directional cues from the US market later.   Commodities, industrials and financials are more than offsetting the decline in telecoms, health care  and consumer goods today. 

Bond markets are trading quietly.  JGBs fell for the first time since the start of the week.  The 10-year yield reached a 7-year low this week, but the market is reluctant to push the yield below 1%.  Next week brings fresh supply.   Calmer markets and the supportive news stream have seen peripheral European bond premiums narrow.   Even Italian bond yields have fallen although the government reported deterioration in finances (June budget surplus of 4.3 bln euros down from 6.2 bln euros last year.

Currency Markets

The release of the US employment data is the main event of the day.    Investors are well aware of the unwinding of the census build, which will produce a headline decline of jobs.  The market will look past this and focus on private sector jobs.  The softer than expected ADP and ISM data yesterday have probably led to downward adjustment to expectations that had been around 100k at the start of the week.  The private sector has added jobs in the past five months and in 6 of the past seven.   To judge whether the labor market is losing momentum (which appears to be the case based on the weekly initial jobless claims), one needs to place today’s report in the context of the recent trend.  Over the past five months the average private sector jobs growth was 99k.  Over the past 7 months its has been just below 70k.  The most recent three month period has seen an average of 139k.  Also note that over the past five months the manufacturing sector has grown jobs, with the average monthly pace being a little more than 25k, which is where the consensus stands.  Hours worked is also an important if under-appreciated aspect of the report.  It is not expected to change from 34.2 hours, but the market’s reaction is likely to be stronger on an unexpected decline than an unexpected increase.   Some have asked about the fishermen in the Gulf of who have lost their jobs.  Our understanding is that fishing falls under farm workers and hence is excluded from the non-farm payroll figures. 

It would seem to take a significant upside surprise to arrest the market concerns that have grown in recent weeks about the US economy.  Most investors seem to take it for granted that European growth would be weak this year.  The shift in market views has been directed at the US and to a lesser extent China.   This comes at the same time that Europe appears to have successfully navigated some treacherous waters—Spain selling 5-year bonds a day after Moody’s puts it on credit watch for a possible (?) downgrade and the ECB engineered a fairly smooth expiry of the large 12-month LTRO.  And these even took place in a context in which the European currencies had begun benefiting for position adjusting, perhaps partly inspired by the approaching quarter end.  The move has taken on a life of its own and yesterday appears to have been one of the top 7 largest single day advances of the euro since 2000. 

This does not mean that the European debt crisis is necessarily over.  The recent positive news stream aside, the strains are still evident.  Easily available metric investors will want to monitor are the overnight deposits at the ECB.  These deposits earn less than they would in the market and high levels of such deposits are similar in some respects to the excess reserves at the Federal Reserve.  It reflects a transmission mechanism still in disrepair.  Another metric to monitor is 3-month euro LIBOR.  It remains elevated.  In fact, some are linking the recent recovery in the euro to the higher short-term rates.  The stress tests and capital that may need to be raised may become a more important focus in the coming weeks.  A report in the Financial Times today cites some expectations that 20 European banks may have to raise a total of 30 bln euros. 

Australia’s new government appears to have worked out a compromise on the controversial resource profits tax.  This may have lent the Australian dollar some support and some mining shares did better as a result of the compromise.  The compromise is a lower headline rate and a narrower application.  The headline rate is reduced from 40% to 30% and this applies to iron ore and coal.  It will still be at 40% for oil and gas projects.  While the initial conception of the tax would have included minerals too, the compromise focuses only on the profits of iron ore, coal, and on shore oil and gas.   The Australian dollar, like the other dollar bloc currencies do better in a more confident global growth environment.  The Australian dollar needs to rise above $0.8550 to begin healing some of the technical damage inflicted in recent days.   The Canadian dollar and Mexican peso would seem even more sensitive to disappointing US employment data.    US dollar support is seen initially near CAD1.0540.    Weaker than expected US auto sales, growth concerns in general and the escalation of violence in Mexico has helped lift the dollar.  With yesterday’s gains the dollar has gained almost 5.5% since 21 June against the peso.   The MXN13.20 is the next target. 

Upcoming Economic Releases
The US employment data is the economic highlight of the day.  There is asymmetrical risk.  The dollar is more likely to generally weaken as expect or disappointing news that rally on better news.  The Bloomberg consensus is for a 110k rise in private sector jobs and a loss of 130k on the headline, with the unemployment rate tick up to 9.8% from 9.7%.