Dollar Soft Ahead of Jobs Report

Highlights
The US dollar rally continued to soften as the market awaits the November jobs report. The market expects a 150k increase in non-farm payrolls with a 158k increase in private payrolls. With the positive upside surprises in the ADP and the employment components of the ISM reports we feel this morning’s report poses some upside surprise risk, which would most likely bolster risk appetite. The euro continues to recover amid further talk of ECB bond buying, which saw further narrowing in euro-zone peripheral spreads. The euro cleared the $1.3250 hurdle with additional support from another good economic data release (retail sales) and is set to test the 11/29 high of $1.3300. Meanwhile, sterling rallied on the back of the rising risk appetite, along with a run of improvement in UK economic data releases, with a run up to $1.5683 subsequent the PMI release. The yen was mostly quiet in the Asian session as most market participants were sidelined ahead of the jobs report this morning. As such, a report in line in consensus may stoke a rise in US bond yields, increasing the yield advantage over the yen, thus strengthening the dollar. Elsewhere, net change in Canada’s employment was below consensus and despite the drop in the unemployment rate (driven by a drop in labor participation as opposed to job creation) weakened the Canadian dollar. The loonie fell back to $1.003 following the print.

Global equity markets are solidly higher, boosted again by strong risk appetite, following the spillover from the US session, healthy global economic data and potential containment of the euro-zone sovereign issues. Namely, Asian stocks shifted higher for a third consecutive session with the MSCI Asia index up 0.5%. Meanwhile, the Nikkei is up 0.1%, led by solid gains in technology and utilities. At the same time, though, the Shanghai Composite is flat as inflation concerns continue to weigh on sentiment following China announcement to prudent monetary policy. European bourses were mostly up, lifted by positive economic data, with the Euro Stoxx 600 up nearly 0.1% led by a gain in technology. Meanwhile, the FTSE and Dax were both flat with the FTSE driven by losses in utilities.

European sovereign bond yields continued to decline with Ireland and Portugal leading the way with a large drop in the 10-year yields as anecdotal evidence suggests that the ECB continues to purchase periphery debt. Ireland’s 10-year yield, for instance, is down 31bp with Portugal’s yield down 23bp. Likewise, Spain’s 10-year yields are down 12bp followed by a 4bp decrease in Italy’s yields. At the same time, Germany rejected issuing eurobonds or increasing the euro-zone bailout fund as Deputy Finance Minister Asmussen dismissed calls for authorities to step up efforts to fight the flare up in bond yields. His statement follows a comment from the ECB’s Nowotny, suggesting that it would be sensible to explore the option of a single Eurobond, although Germany would stand to lose the most as its refinancing costs would likely increase. Elsewhere, Brazil’s central bank raised reserve requirement on cash and time deposits, stoking speculation of a possible rate hike down the road.

Currency Markets

The ECB must be pleased with itself. The strategic ambiguity card that Trichet played yesterday is succeeding in supporting the peripheral bond markets and a relaxation of prices in the credit default swaps market. Because the ECB never indicated a amount of sovereign bonds it would buy, an increase, as we have saw last week and this week, does not require an announcement or change of stance. The ECB’s Nowotny acknowledged that purchases were "energetic" this week. Recall that in the first week of the sovereign bond purchases back in May, 16 bln euros purchases were made. Last week, the ECB purchased around 1 bln euros of sovereign bonds. Estimates for this week’s purchases are around 5 bln euros. The market learns of the size of the purchases primarily through the size of the sterilization effort. This is indicated late Mondays in Europe and will be a key focus for investors in the coming weeks. However, we remain skeptical that this will stem the tide for very long.

First, it does not address the funding for banks, such as those in Portugal and Ireland that have been locked out of the wholesale funding market since April/May. With the ECB extending its emergency liquidity provisions through Q1, this enables continued dependency, which is really unsustainable. Second, it will not stop the rot from growing. Specifically, Moody’s placed six top rated Irish mortgage bonds on negative watch and S&P announced that it was placing Greece’s sovereign BB+ rating on negative watch. S&P also placed Portuguese bank on credit watch for possible downgrade (currently A1 long-term and A2 short-term. Third, the political fallout from the crisis will continue. The ruling Fianna Fail party in Ireland has seen its public support fall to new lows and this underscores the risks that new week, the Irish parliament fails to approve the 2011 budget, which is ostensibly part of the basis for the aid package.

The pricing of credit-default swaps on Italian banks have risen this week. Prime Minister Berlusconi faces a confidence vote on December 14 and many expect his government to fall. It is Belgium that has the dubious honor of having the worst performing bond market in the euro zone this week. It is among the most indebted euro zone member and, although its economy is expanding and it enjoys a current account surplus, it has been unable to form a government several months after the national election. The government has to roll-over 75 bln euro of debt next year, and like Spain and Italy it is front loaded, concentrated in Q1 11. Like several peripheral countries, banking assets in Belgium are a multiple (3.5X) the size of the economy. In terms of the euro itself, the recovery in peripheral bonds have sparked a short-covering rally in the euro. The euro approached the $1.3280 area. A convincing break of this area could spur as much as another 2 cent advance from a technical perspective. However, we think that participants will be reluctant chase the euro there ahead of the Irish budget vote. Also, the 2-year US-German interest rate differential, which has tracked the euro-dollar exchange rate so well, is still moving in a dollar-supportive direction.

Upcoming Economic Releases

At 8:30 EST / 12:30 GMT US reports November’s employment report. Despite the expected increase in payrolls the unemployment rate is expected to remain unchanged at 9.6%. Afterwards, factory orders are expected to drop to -1.2% from 2.1% with a marginal increase in ISM non-manufacturing. Elsewhere, Mexico’s consumer confidence is expected to increase to 90.1 from 89.2.