Strong US Data Sees Split Market Reaction

The US economy supposedly added jobs at a furious rate in December – particularly according to the record job additions seen in the household survey. The kneejerk reaction in the USD was somewhat bifurcated.

Bifurcated USD reaction to NFP
The immediate reaction to the strong US employment data was rather bifurcated, so while USDCAD AUDUSD and USDJPY have largely followed our script in the wake of the report – the action against the European majors have so far not done so, likely due to the very significant upside surprise in payrolls/household survey. Let’s wait a day or two before we have a verdict.

The USD was generally down against the most obviously pro-risk currencies like the Aussie and Loonie, but actually strengthened a bit against the other “non-yielding” currencies (EUR, CHF, GBP, JPY). The implication is that the market is dallying with the “relative central bank balance sheet” game among the non-yielders while preferring to continue to bid up risk and the economies where there is still some yield and the perceived potential for stronger growth. This was interestingly even the case initially with USDCAD after Canada saw a rather bad employment report today as that pair went from 1.0030 before the report to back to the lower end of the range in its wake.

It’s no great surprise to see the initial rally in USDJPY as bonds sold off rather sharply on the US jobs data, though that sell-off has been rather modest thus far relative to the upside surprise in the data. (9 bps rise in yield on the US 10-year benchmark as of 45 minutes after the employment report) Still, the overall momentum and sentiment on the USD has been negative of late and this data was so overwhelmingly strong that it has scrambled the picture a bit here relative to the reactions we had anticipated had the report been merely positive rather than extraordinarily positive.

On that last note, one key question to ask after a data report like the one we just saw – could we see another couple of months of data like this and if so, will the market start to ask whether the Fed has their forecasts completely wrong? If that indeed turns out to be the case, the latest FOMC statement/forecasts will have been somewhat akin to the ECB hiking rates in June of 2008 – just as world markets were about to completely melt down. One market to watch for that possibility besides the USD itself is the US bond market and whether/how deeply it sells off from here. And in the instance of an appreciable rise in yields – could we eventually see the brakes applied to asset markets and thus a stronger USD as central banks threaten to cinch off some of the flow from the liquidity fire-hose? That question will take some time to answer – not one for today and maybe not for next week either.

More bad Euro news
While the market has been focusing on the US data today, we’ve had a few more negative EU developments today. Spain’s Jan. Services PMI recovered slightly, but is still rather recessionary at 46.1, while Italy’s Services PMI came in at a miserable 44.8. The “two-speed “ Europe  problem remains as German PMI’s have improved over the last couple of months. Elsewhere, rumours are swirling that Greece’s PM by appointment Papademos is threatening to resign if the interim government won’t agree to a new budget/financing plan. And the EU’s Juncker has cancelled next Monday’s Eurogroup meeting, reportedly as talks among the Troika and with Greece remain at an impasse.

Looking ahead
The above comments were written before the release of the US January ISM non-manufacturing number, which was far stronger than expected as well, with the New Orders and Employment sub-indices jumping very strongly. The strong data (Or was it strong – there are certainly ways to read some of the employment data that suggest something fishy going on - no matter as long as market perceives it is strong for now – and these interpretations would be more convincing if we hadn’t just seen a very strong ISM non-manufacturing employment index for January.) certainly has the upper hand for now and the USD is likely to continue to suffer in the near term, save possibly for vs. the JPY if bond markets remain weak, as it will remain a funding currency for the carry trade if the global mood remains positive and the market doesn’t begin to fret the withdrawal of liquidity (far too soon to predict a Fed turnaround just yet – but QE3 is beginning to rapidly recede). Eventually the market will realize it can’t have its cake and eat it too, but for now, it certainly is enjoying bellying up to the punchbowl. A wonderful mixed metaphor to start your weekend….

Next week is an important one for Europe as the situation in Greece drags on and as we still don’t have further news on Portugal, where the debt dynamics are unsustainable and the need for a second bailout deal lurks as a possibility, further testing the political resolve of the EuroZone. As well, a lame duck Sarkozy remains a background threat considering the import of the Franco-German dealings in establishing policy direction. The ECB is up next Thursday as well. The situation remains very tenuous for Europe.