All eyes on US jobs data today

BBH CurrencyView

• All eyes on US jobs data today, FOMC meeting next week
• Euro zone periphery remains under pressure as ECB said to buy bonds; data softer than expected
• Global equity markets are lower as growth risks, sovereign risks persist; EM FX softer too

Markets are still trading with a negative tone ahead of the much awaited NFP. The dollar is mixed against the majors, rising sharply against NZD, AUD and CAD, flat against EUR and CHF, but weaker against JPY. USD/JPY rebounded to 78.40 from a recent intra-session high of 80.24 yesterday in the wake of BOJ intervention. Global equity markets re-priced following yesterday’s sharp fall in the S&P. The Euro Stoxx 600 is -1.5% while US futures are pointing to a -0.2% open ahead of this morning’s data. European periphery yields are mostly lower, supported by ECB buying and positive comments by S&P ratings about Ireland. The more notable moves were declines of 27 and 17 bp in Spanish and Irish 10-year yields, and 95, 21 and 14 bp declines in 2-year yields for Portugal, Ireland and Spain, respectively. Energy futures seem to have stabilized after yesterday’s 5% decline. EM largely softer.

All eyes on US jobs data today. Bloomberg consensus is for +85k NFP in July vs. +18k in June. If NFP headline comes in much higher, there is potential for a near-term bounce in equity markets and sentiment; if it comes in much lower, it would firm up expectations for QE3 and perhaps give risk assets a bit of a cushion. The problem with that is next week’s FOMC meeting is unlikely to yield anything concrete beyond acknowledgment of the weaker US outlook. Markets will likely have to wait until August 26, when Bernanke speaks at Jackson Hole, to get a more clear reading on QE3 potential. The worst outcome for markets would be a number at or near expectations, which perversely would confirm the negative sentiment and potentially continue the current selloff.

Euro zone numbers continue to soften, underscoring the global nature of the slowdown. Spain reported June IP dropping -0.6% m/m and -2.7% y/y today, and a slowing economy will only make it tougher to improve the fiscal numbers. Bank of Spain estimated today that GDP rose 0.2% q/q in Q2 vs. 0.3% q/q in Q1, and that home price declines accelerated in Q2 compared to Q1. Italy IP showed similar weakness, falling -0.6% m/m (SA) but eking out a 0.2% y/y gain. Italy also reported Q2 GDP today, showing a modest acceleration to 0.3% q/q from 0.1% q/q in Q1. But with structurally slow growth (averaging 0.3% per annum over the past decade), how can Italy improve its fiscal outlook? Lastly, even Germany is not immune as June IP was reported today at -1.1% m/m. Though the y/y rate of 6.7% looks good, it has slowed sharply from 15% y/y in February. As growth slows in the euro zone, we think downwards ratings pressures will pick up again, which would be euro-negative.

Ireland gets a pass from S&P as it affirms BBB+ rating, but we see ongoing euro zone downgrades ahead. Our sovereign ratings model shows Ireland as BB+/Ba1/BB+ vs. actual ratings of BBB+/Ba1/BBB+. Moody’s has it right, but the others are three notches too high. Spain is way out of line as our model shows it as A-/A3/A- vs. actual ratings of AA/Aa2/AA+. Italy should be downgraded as we view it as A-/A3/A- vs. actual ratings of A+/Aa2/AA-. Portugal too should be cut, as we view it as BB/Ba2/BB vs. actual ratings of BBB-/Ba2/BBB-. As we’ve noted in recent weeks, the weaker core countries are under pressure, mainly France and Belgium. France slipped into borderline AA+/Aa1/AA+ territory, so while the case for a cut is not that strong yet, risks to its AAA are rising as stresses spread. Belgium has a clear case for a downgrade, as our model rating of AA/Aa2/AA is firmly below actual ratings of AA+/Aa1/AA+. Lest we appear to be picking on the euro zone, we note that our model is showing downgrade risks for UK (AA/Aa2/AA implied vs. AAA/Aaa/AAA actual) and Japan (A+/A1/A+ implied vs. AA-/Aa2/AA actual). Lastly, while our model shows US at AAA/Aaa/AAA, a cut is likely given that the debt deal did not do enough to improve medium-term US debt trajectory.

Turkey tries to shore up the lira. After yesterday’s decision to cut the target rate by 50 bp, the central bank reduced reserve requirements on FX holdings by 50 bp, reportedly adding $930 mln of FX liquidity to the market. There is also talk in the local media that the Fin Min is looking to place a tax on FX income and swap transactions. Between lower FX reserve requirements, selling USD from reserves and regulatory measures, the central bank will probably be able to ensure ample USD liquidity for now, but that does not mean that negative sentiment towards the lira will change. FX measures will provide only temporary relieve, in our view, and so TRY to remain under pressure.