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Today's US employment report is likely the worst yet

Fri, Dec 5 2008, 09:45 GMT
by John Hardy

Saxo Bank

HEADLINES

• US Nov. ICSC Chain Store Sales fell -2.7% YoY vs. -1.1% expected

• Australia Nov. AiG Performance of Construction Index fell to 32.0 from 36.4 in Oct.

THEMES TO WATCH – UPCOMING SESSION

Events Today:

• Norway Oct. Industrial Production (0900)

• Germany Oct. Factory Orders (1100)

• Canada Nov. Unemployment Rate and Change in Employment (1200)

• US Treasury's Kashkari to Speak on TARP (1300)

• US Nov. Change in Nonfarm Payrolls (1330)

• US Nov. Unemployment Rate (1330)

Market Comment:

Yesterday's action was inconclusive yet again, with the greenback and JPY reaching for new levels of strength ahead of the major European central bank announcements, only to find themselves smacked back into the range in the wake of these meetings. The ECB cut by the 75 basis points that were widely expected, even if there was heated talk (including from ourselves) that they could chop rates by 100 or 125 basis points as this kind of move was overdue. The BOE "only" lowered rates about 100 basis points after the market was divided about evenly on whether the Bank could move 150 basis points.
Most surprisingly, Sweden's Riksbank moved forward much of its rate adjustment by whacking a huge 175 basis points off its rate all in one go.

BOE decision

GBP traded to record lows against EUR and briefly touched new lows against the USD after the BOE accompanied its decision with a statement that appeared to indicate acceptance, if not encouragement, for the pound's weakening. The bank noted that the weak pound could moderate the impact of weak global growth. On the other hand, the bank also noted that the pound's drop has "raised the inflation profile." This is a bit conflicting, but the overall impression is perhaps: the bank is happy to see the pound decline, but it wouldn't want the decline to become disorderly. The latter consideration is possible grounds for the 100 bp cut rather than a larger one.

ECB saving some of its rate for even darker days?

Trichet noted at the ECB this idea again that the bank would like to hold back from cutting too much now in an effort to save room for easing further out as "we have to beware of being trapped at nominal levels that would be much too low". This kind of logic seems hopelessly behind the curve - and we suspect that the ECB will be forced in due course to lower rates toward 1.00% and lower by mid 2009. When asked about the subject of inflation, Trichet replied that he does not regard deflation as a threat and said the ECB could buy assets if necessary, without any further explanation. If we use the model of "whatever hits the US, eventually crosses the pond and hits the EuroZone as well", then the ECB will have plenty of explaining to do in due course as the EuroZone will inevitably need to figure out a way for member countries working with the ECB to expand the public balance sheet dramatically in coming quarters just as the US Fed has done if it wants to prevent the collapse of financial institutions and corporations. The latter are especially at risk in Europe because they hold enormous amounts of shorter term debt and refinancing costs are astronomic if nothing is done to address the problem.

US-China talks yield little.

The US-China economic dialog talks seemed to have mostly centered on shoring up the stability of the financial system, an understandable worry on China's part after all of this turmoil, considering its enormous holdings of US debt. The talks ended with no substantive announcement on Chinese currency. Instead, measures were announced to allow freer access by Chinese banks in the US market and various other "agreements" were likely on electricity generation, environmental issues, etc.. The talks were unlikely to lead to much substantive with Paulson as the lame duck US treasury secretary. We will have to wait for Obama and Geithner and company to see whether the Strategic Dialog framework continues and how combative the president-elect remains on the Chinese currency, after using it as a populist issue in the campaign. Will the Chinese continue to keep the Yuan in this range just below 7.00, or will they allow some weakening of the Yuan to test the Obama team's resolve ahead of inauguration? This is a huge issue.

US employment report

Another fearsome US employment report is on tap for today, as the US economy may have lost more jobs in one month than at any time since the early 1980's. Expectations for the Change in non-farm payrolls are running for a drop of well over 300k. The unemployment rate is expected to jump again, this time to 6.8%. There is nothing to suggest any chance of upside surprise on this data. The question is how dependent the USD is on economic data after yesterday's attempt at a reversal.

CAD under pressure

CAD fell sharply across the board yesterday on another wave of capitulation in crude oil prices and on developments in Canadian politics: as PM Harper convinced the Governor General to suspend parliament until late January in a bid to save his government from a confidence vote and attempt to refocus the legislature on the budget. This was an unprecedented move. Also, the bottom fell out of the Canadian Ivey PMI yesterday, which registered its lowest level in the near 10-year history of the survey. It would appear that a test of the 1.3000 level in USDCAD may be in the works soon.

Market action

Equities sold off sharply later in the US session, and this took the JPY stronger again after the short squeeze earlier in the day had driven the JPY sharply weaker. These markets are indeed treacherous as directional signals last mere minutes before reversing course. CHF also woke up and got back on its old safe haven horse briefly, and EURCHF dipped to test its 21-day moving average again before easing back higher overnight as the equity sell-off failed to turn into a rout. We really need a breakout of some kind that holds to get a better directional indicator.

The parabolic drop in US yields at the long end is due to the clear intention by the Fed and Treasury to try to control the long end of the government yield curve, in an effort to shore up the housing market. The dramatic fall in mortgage rates (due to outright purchase of GSE mortgage debt announced previously and the indication that the Fed will likely monetize debt down the road) has seen a boom in refinancings. US yields are plummeting relative even to European yields all along the curve, and thus not really providing any support for the USD in terms of interest rate differentials. This action looks downright panicky and unsustainable.

Chart: EURUSD technical view

The move yesterday in EURUSD forces us to neutralize the short term view on the USD, after we were looking for it to head stronger on the other side of all of this, since yesterday saw a new low quickly rejected and an ensuing rally in EURUSD. EURUSD will need to work back below 1.2550 and GBPUSD back below 1.4500 for the technical arguments for a stronger USD to resume. Nonetheless, we are still in a longer term range here and two previous large outside days (when highs and lows exceeded the previous couple of days trading ranges) yielded no new sustainable directional action. 1.2850 is the short term resistance and breakout level for the bulls.

Published on  Fri, Dec 5 2008, 10:23 GMT