Jobs, Jobs, Jobs

BBH CurrencyView

• Markets choppy ahead of the US employment report; global stocks mixed, commodities softer
• US economic data performance continues to outperform; Sep. Canadian employment surges
• Custody holdings at the Federal Reserve for foreign central banks continue recent decline

The markets continue to remain choppy ahead of the US jobs reports, while keeping a close on the political developments shaping up in Europe. Asian stocks (barring China, which is on holiday) have rallied again, with the MSCI Asia-Pacific Index up over 2.5% today, making the recent two-day gain the steepest rise the index has seen since April 2009. The ebb and flow of European stocks today highlighted the mood, which saw early session gains in the DAX swing nearly 1.2% to return to near net unchanged levels on the day. Merkel, Sarkozy, and finance ministers will meet Sunday for new discussions, but Germany already made clear that it wants strict restrictions for the EFSF and doesn’t see immediate need for bank recapitalization, prompting the swing in European stocks. Other banking news saw Moody’s downgrade 12 British financial institutions. Elsewhere, Canadian September employment surged 60.9K, exceeding the consensus high by nearly 26k jobs.

Today the market attention shifts back to data. US jobs, in particular. Overall, US economic data reports continue to show a US economy that is performing ok – not fast enough to close the sizeable output gap, but ok. US economic data surprises (z score of consensus vs. actual) suggest that the magnitude of the US data surprises have exceeded expectations by a z score of nearly +0.4, driven the strength of “hard” data surprises that include retail sales, industrial production and so on. On a relative basis US data surprises have outstripped nearly all countries in the G10 except Australia, Sweden and Japan, suggesting for now that the worst of the US slowdown may be priced. Indeed, it appears likely that for the moment the US economy is hovering above stall speed but in fact is unlikely to have fallen back into recession. The market expects private payrolls to increase by 90K, with no change in the unemployment rate. Barring the change from the Verizon strike, we suspect that payrolls are likely to surprise on the upside in line with other US economic reports and in turn would expect the recent short-covering rally to continue, given the sharp changes in market positioning that have taken place. In our view a positive surprise would likely result dollar weakness, with the currencies most sensitive to equity market swings likely to perform the best (CAD, AUD, NZD, EUR according to a 30-day rolling correlation). In terms of magnitude year-to-date the outcome of the employment report have been split right down the middle with four upside surprises and four downside surprises. Generally upside surprises have been met with dollar losses averaging losses of between 0.75 – 0.9% against the dollar bloc (DB) following the release, while negative surprises witness sharp dollar rallies against the EUR and SEK, between 0.8-1.0%. Of course, the magnitude of the currency change depends largely on the magnitude of the surprise. This year the median downside and upside “misses” were -83k and +33 and both, on average, were nearly one standard deviation from consensus. That means, a payroll’s print 66k or below is likely to see the dollar move sharply higher, while a print at or above 120k should see the dollar decline against the DB and EUR. We see EUR/USD resistance near 1.35.

The custody holdings at the Federal Reserve for foreign central banks continued to fall in the week through Wed, bringing the decline to about $62 bln since late August. The decline in custody holdings reflects central bank intervention to support their currencies amid the exodus of hot money flows. Who actually uses the Fed’s custody services is not known, but there have been a number of central banks that have been intervening, some in the open and some more discreetly. Several East Asian central banks are believed to have been intervening, though confirmation is lacking. Turkey has been more explicit. The central bank has sold $1.3 bln this week alone and offered an additional $750 mln in a daily auction today. The central bank interventions are likely to depress reserve figures. However, valuation will also play a significant role. Japan reported its reserve figures earlier today. They declined to $1.2 trillion, a decline of almost $18 bln. Of that decline $13 bln is accounted for by foreign currency reserves (separately BOJ drew down its deposits held by both domestic and foreign banks, including central banks). Assuming that there was no intervention in September, after that record one day intervention in August, the change in FX reserves is a function of the shift in valuation, owing to the euro’s 6.6% decline against the dollar. The large euro decline against the dollar in September (and to a much less extent sterling -4.6%) will impact those central banks that have diversified their reserves the most. EM action today likely to be driven, of course, by outcome of NFP.