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US jobs data leaves the market confused

04/02/11 @ 14:18 GMT by Simon Smith, Chief Economist

This was one of those classic double-takes by the market on the US employment report.  The dollar initially rallied on the much lower than expected 36k rise in headline payrolls, but the decline in the unemployment rate from 9.4% to 9.0% then caused the initial move to more than reverse.  
So what's going on?  Well, weather played a part, that seems pretty certain.  The establishment survey, which churns out the headline payrolls numbers, said that 886k workers could not get to work during the survey this week.  The impact of this on the headline numbers is not clear, but it would have certainly dragged them lower (normally 282k workers are affected by weather in January).  Unsurprisingly, construction employment fell 32k during the month, again no doubt weather related.  
The fact that non-farm payrolls deviated so strongly from the message from the unemployment is not unusual (given totally different basis for each set of numbers), but nevertheless is historically on the extreme side.  The other factor to note is that the indications from some of the ISM surveys were also bullish on the employment side.  There will no doubt be suggestions that these numbers will be prone to revision, but the 18k upward revision to December's disappointing reading has not added much weight to this scenario.  The head of the US Federal Reserve again repeated yesterday that it would be several years before the unemployment rate returns to more normal levels.  Despite the January jump lower on the rate and it's worth keeping the magnitude of the task in hand to the fore during these monthly gyrations.



Market better positioned for strong employment report

04/02/11 @ 08:07 GMT by Simon Smith, Chief Economist

Thursday was a fairly brutal day in fx markets, with the euro correcting substantially in the wake of the ECB press conference and later powered by the further strength in the US non-manufacturing ISM data.  As a result, the dollar index has also corrected nearly 1% higher, which technically now brings into doubt the sustainability of the dollar down-trend seen since early January. Of course, today it's all about the US employment report.  Whilst the street is anticipating a 146k increase in non-farm payrolls, all the indications after this survey have been for a firmer outcome, both in the form of the ADP numbers and also the employment balances in the ISM surveys this week.  So, expect a strong number (nearer 200k) and brace yourself.  

Commentary

Market now taking more measured approach to ECB's tightening.  The heavy lifting was achieved in January, so the ECB President took the view in his press conference following Thursday's meeting that his work was done.  With the euro over 2% higher compared to mid-January, short-term money markets' rates having normalised and two-year swap rates some 25bp firmer (and standing 100bp over the benchmark rate), financial conditions had already essentially been tightened.  The reaction in fx and also interest rate markets reflected the fact that they had got ahead of themselves expecting a further ratcheting up of hawkish rhetoric in the wake of higher prices and activity data since the last meeting.  Higher rates remain more than likely this year but, given the divergences in economic and financial conditions across the eurozone, the ECB is right to take a more measured approach.
More tensions on euro stability facility.  EU leaders meet today to attempt to hammer out more details on expanding and also enhancing the European Financial Stability Facility.  There are signs that this is not going as smoothly as anticipated, with Bloomberg yesterday reporting further splits between France and Germany on the issue of buy-backs by peripheral countries.  The impression gained is that reaching agreement on all the elements ahead of the March 25th summit, which is meant to tie it all together, may not be as easy as initially anticipated. Furthermore, it's not necessarily going to be the panacea that markets were perhaps anticipating.  
Commodities continue to boom.  Prices show absolutely no signs of letting up, with still more record highs being recorded this week. Copper is trading at just under $10,000 a metric ton, a three-fold increase since the end of 2008. Both rubber and sugar are at record highs. The price of Brent crude reached a 28-mth high of $103 a barrel Thursday, a 50% increase in just the past nine months. According to the UN Food and Agriculture Organisation (FAO), world food prices surged another 3.4% last month to a new record high, led by outsized increases in sugar, dairy, oilseeds and wheat. Since 2002, the FAO food price index has almost tripled. In India, food inflation rose to 17% YoY in the week ended January 22nd, led by a 77% jump in vegetable prices. It is difficult to exaggerate the pervasive negative effect that soaring agricultural and non-agricultural prices are imposing on the developing world right now. For those countries where incomes are relatively low and the dependency on imports is high, this extraordinary hike in the prices of raw materials represents an enormous tightening of financial conditions. Inflation is the number one risk right now in developing markets. For fx markets, it implies continued gains in major currencies such as the euro, pound, Swiss franc, the Aussie dollar and the Norwegian krona, vis-a-vis the currencies of developing countries.
February MPC decision closer to the knife-edge.  After the strong bounce back in the services PMI data in January, next week is going to be a nervous time for sterling.  The market is just about priced for a tightening of policy at the May meeting.  There is risk of a move next week (perhaps 30%), but King's recent staunch defence of the Bank's record - and his view that inflation is still primarily owing to one-off factors - is likely to win over. One more MPC member moving over to the tightening camp (minutes are released two weeks later), could well shift the balance towards a move in the subsequent 1-2 months. Nevertheless, the market is set to be very nervy ahead of next week's monetary policy meeting. Historically, around half of all rate moves have occurred in quarterly inflation report months (of which February is one), given that these are the times when the MPC sits back and considers the wider picture of the inflation outlook.  Furthermore, with two members having voted for a tightening in January (when December's inflation data was available to them but not the Q4 GDP), then it's likely that the rate-tightening proposal will be vigorously discussed in the meeting.

Looking Ahead

Friday: CA: Unemployment Rate, January (expect 7.6%, previous 7.6%), US: Change Non-farm Payrolls, January (expected 135k, previous 103k), unemployment rate (expected 9.5%, previous 9.4%).

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