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Fed Statement Will Be Bitter Recipe for the Dollar

Fri, May 4 2007, 14:14 GMT
by Ashraf Laidi

CMC Markets

Weak Payrolls Strengthen Case for Fed Cut

Today’s jobs report showing the weakest net payrolls increase in nearly 3 years (88K lowest since November 2004) one week after Q1 GDP growth slowed to its lowest in 4 years should further open the door for a Q3 rate cut. The report also comes 5 days after the latest inflation figures showed market decline in price pressures (see below), weakening the Fed’s argument of inflation vigilance .

The breadth of the weakness in today’s jobs report must not be ignored. The services sector, known for its strength, has seen net job creation slow to 116K--the lowest level since June 2006. Its 3-month moving average dropped to its lowest since July 2006.

Manufacturing jobs fell by 19K in April, extending losses for the 10 th consecutive monthly decline. This was the longest monthly decline since 2003-2004.

Construction lost 11K jobs, reverting in the red after a 50K increase in March and 77K decrease in February.

Average hourly earnings slowed to 0.2%, while the number of hours worked also moved lower, reflecting the slowdown in personal incomes. 

With the manufacturing sector in a recession and the housing slowdown not yet reaching bottom, the case for a Fed cut this year is further strengthened. Monday’s release of the core PCE price index showing a slowdown to 2.1% from 2.4% also reduces the case for the Fed’s inflation vigilance. Slowing inflation as measured by Monday’s core PCE release is consistent with the March CPI data released in April 17th showing core CPI growing 0.06% m/m in March, its lowest rate since April 2005, and 2.5% y/y from    2.8%--lowest since cay 2006. The data places the Fed’s inflation rhetoric in doubt and leaving the market to worry about slowing growth. The year on year core CPI dipped to 2.5% from 2.8%, its lowest rate since May 2006.

Next Week’s FOMC Statement: A Bitter Recipe for the Dollar

Considering the softening in inflation data (core PCE and core CPI), the prolonged weakness in employment, continued erosion in housing and recession in manufacturing, the Federal Reserve will have no choice but to maintain its downgraded growth outlook, while softening its inflation preoccupation. This should be a fresh recipe for further dollar declines as it opens the door for a 25-bp rate cut as early as August. Although we continue to see the possibility of a rate cut as early as June, fed funds futures are a pricing a rate cut as early as October.

In contrast, Thursday’s Bank of England decision is widely expected to produce a 25-bp rate hike to 5.50%, while the European Central Bank is expected to open the door for a June rate hike. These developments are expected to prolong the euro’s bullish run, whose sustainability has rested on periodic retreats—an effective means of avoiding rumblings from European politicians.

Published on  Fri, May 4 2007, 14:16 GMT