Risk sentiment has soured sharply in the run-up to the NFP report

BBH CurrencyView

• Dollar is mostly firmer against the majors as recent risk rally stalls; US NFP is major focus today
• Euro zone jitters pick up after troika suspends Greek talks temporarily; Italy also back in focus
• EM sentiment remains poor after Brazil rate cut; other risk assets remain vulnerable too

Risk sentiment has soured sharply in the run-up to the NFP report. Defensive plays dominate price action across asset classes. European equities have sold off sharply in the a.m. session with the Euro Stoxx down 2.4%, on weakness across financials (-3.2%), basic materials (-3%), industrials (-2.6%) and oil&gas (-2.1%). National bourses are deeply in the red, led by the periphery with Greece underperforming sharply, down 4%. The euro remains sharply weaker across the board weighed down by news of a premature end to the “Troika” IMF/EU/ECB consultation with Greece, as well as more negative unemployment figures out of Spain. The biggest risk is that the ECB runs out of “political credibility” capital to continue purchases of government bonds in the periphery and the sharp spike in Italian (+13bps) and Spanish (+9bps) 10yr spreads against Germany’s benchmark this morning suggest that European financial systemic stresses are back on the rise as the ECB retreats. Reserve managers continue to defend the 1.42 level for EUR/USD but the 1.11 level for EUR/CHF has come under attack and EUR/JPY continues to trade heavy below 110 in spite of growing intervention fears.

Greece and euro zone developments are also taking a turn for the worse. Greece’s meeting with the troika (ECB/IMF/EU) was reportedly called off, with the troika leaving Athens. Greece Finance Minister Venizelos said that the meeting was temporarily suspended to further study data and that talks will resume in mid-September. Greek press reported that the impasse is coming from government reluctance to take steps to fill a 1% of GDP budget gap. While this sort of back and forth is not that unusual in an IMF program that is starting to go off the rails, the stakes are high and such public disagreements do not look good during this time of heightened market nervousness. Still, this does highlight the intractable problem that Greece (and others) faces: how to tighten fiscal policy without starving growth. The numbers are simply going to get worse for Greece, and further austerity only exacerbates this dynamic. While the euro zone problems have gone well beyond Greece, the fact that policy-makers cannot even handle this relatively small problem does nothing to instill confidence that the wider debt crisis can be dealt with successfully. Indeed, Italy is back in the spotlight due to a public standoff between the ECB and Italy following PM Berlusconi’s U-turn on the austerity measures announced just before the central bank launched purchases of Italian government bonds in August. For now, the Swiss franc is likely to continue its recent recovery.

The US August NFP is set to test market nerves today. Consensus surveys place expectations for the August US non-farm payrolls gain at just below 70k but in reality the dispersion of expectations is extraordinarily wide, ranging from -10k to 160k, which mirrors the type of exceptional volatility that accompanies turning points of the real growth cycle. The ADP private sector results and producer surveys argue against a negative NFP print; indeed the evidence suggests that employment may not have fully adjusted to the slowdown in economic activity since earlier this year. However the strike by 45k Verizon telecom workers in August and the continued drag from public sector (a 25k drop implied on the consensus forecast, following July’s 39k decline) suggest that risks are skewed heavily to the downside.

The unexpected 50 bp cut by Brazil had added to negative market sentiment, with EM FX largely weaker in the aftermath. No surprise that BRL underperformed Thursday, but EM weakness has carried over into today. TRY has taken it on the chin today, highlighting what we think will be a recurring theme for EM going into year-end. That is, countries that are running questionable macro policies are likely to underperform. Lira weakness was also aided by weak PMI today, with Turkey reporting a sub-50 number of 48.8 in August vs. 52.3 in July. Brazil reports Q2 GDP later today, and while softening is expected, we still disagree with the decision to cut rates 50 bp this week. Elsewhere, renewed CHF strength will take a toll on CEE, especially Hungary and Poland, where CHF-denominated loans are significant. We continue to favor PLN over HUF, but EMEA remains the weak link in EM and the region is underperforming today.