After Ben, Markets Brace for US Payrolls

BBH Weekly FXView

The impact of Fed Chairman Bernanke’s testimony – his assessment of the economy and the further accommodation that can be provided to stem economic stresses into next week – will dominate market action into the next week. The G10 currency complex has been highly sensitive to the global risk environment. The potential to break outside recent ranges is down to the policy responses to the crisis together with the continued evolution of the growth figures with elevated volatility levels indicating the markets are preparing for further disruption ahead.

Fundamental concerns are unlikely to dissipate with the signals from global cycle leading indicators feeding market fears that the worst still lies ahead. The market expect that US non-farm payrolls posted a 90k gain in August, down from 117k in July, which would leave the 3-month pace at 72k, significantly below the ytd average of 135k and the 200k pace enjoyed in the early months of the year. On the positive side, July real, inflation-adjusted PCE is expected to post an increase after consumption stagnated in Q2, although softer labor markets create a great deal of uncertainty with respect to the outlook, with consumer sentiment collapsing to historic lows this month. The bias towards further cash hoarding by corporates off the back of difficult primary market conditions, negative productivity growth over the past two quarters and increased macro-economic uncertainty points to a more volatile payrolls outlook ahead.

The August ISM manufacturing PMI (September 1) is expected to dip below the 50 mark for the first time since the 2009 recession. Although a reading below 50 is not necessarily consistent with a recession, the fact that the slowdown is led by the liquidity-rich, global-trade-dependent is a signal that cyclical concerns are unlikely to find a floor over the near-term. Any better than expected surprises in the growth figures are more likely to play into market momentum, by upgrading expectations of the slope of the economic trajectory, rather than alter perceptions of the direction. US TIPS 10yr real yields have fluctuated in a 0-0.6% range over the past month – a signal of the level of growth that markets expect that the economy can sustain over time.

The euro remains driven by the EU’s management of its crisis rather than by sovereign default risk. The ECB remains present in Italian and Spanish markets this morning near which means that the markets continue to trade the euro zone crisis as a banking crisis rather than as a euro break-up risk. The concern, however, is that political disunity and deeply-rooted fiscal disagreement will cause further delay to the implementation of the July 21 EU Greece, EFSF deal which will render the ECB running short of political collateral to extend purchases in Spanish and Italian government bonds. German opposition to the Eurobond idea has unsurprisingly also translated into questioning the ECB’s mandate for continued bond purchases, which highlights a major political risk ahead. German constitutional court..

Sterling has been the third worst performer this week, reflecting a general fatigue in haven positioning ahead of the Jackson Hole meeting, with general thinking about the potential for more SNB and BoJ action also playing into that. The pound’s recent strength has been largely on account of short market positioning into the recent rapid repricing of risk in equity markets and the destruction of leverage in the G10 high-beta growth complex rather than on account of an improvement of the market’s thinking of UK fundamentals. Norway has been the best performer of the past week, reflecting a growing search for more attractive risk/rewards in an environment of high volatility and macro-economic uncertainty.

The Japanese government announced a $100 billion loan fund and strengthening monitoring of FX markets to stem JPY appreciation. Under the loan program, the government will send foreign currency reserves to the Japan Bank for International Cooperation (JBIC) for funding to spur Japanese spending on corporate acquisitions and resources overseas. JBIC will provide Japanese firms with lower interest rate. As the monitoring reinforcement plan, the government will oblige main financial institutions in Tokyo FX market to report about positions in proprietary trading twice a day. Reporting obligations will continue until the end of September. If there is a false report penalty is applied. It seems that the measurement gives only psychological pressure and has limited impact on USD/JPY and Yen crosses. The Japan showed clearly that they can do little besides intervention, and after all the market expects the official will just intervene and BOJ will strengthen monetary easing. BOJ might expand yen supply to private banks to enhance effectiveness of loan fund by JBIC.

Central Bank Meetings: RBA (9/06), Riksbank (9/7)