Upside US ADP employment change surprise latest fuel for the risk appetite fire

Key ECB meeting on tap tomorrow.

Key issue will be ECB guidance on potential for asset purchases. USDJPY: flirting with 200-day moving average.

MAJOR HEADLINES – PREVIOUS SESSION

• Australia Mar. Retail Sales out at +2.2% MoM vs. +0.5% expected and -2.0% in Feb.
• Australia Mar. Trade Balance out at 2498M vs. 1700M expected
• Germany Apr. Final Services PMI out at 43.8 vs. 43.5 original estimate
• EuroZone Apr. Final Services PMI out at 43.8 vs. original 43.1 estimate
• UK Apr. Services PMI out at 48.7 vs. 46.3 expected and 45.5 in Mar.
• EuroZone Mar. Retail Sales out at -0.6% MoM vs. +0.1% expected
• US Apr. Challenger Job Cuts rose 47.0% YoY vs. 180.7% in Mar.
• Norway Norges Bank lowered deposit rates 50 bps to 1.50% as expected
• US Apr. ADP Employment Change out at -491k vs. -645k expected and -708k in Mar.
• Canada Mar. Building Permits out at +23.5% MoM vs. +2.3% expected and -15.8% in Feb.

THEMES TO WATCH – UPCOMING SESSION

• Canada Apr. Ivey PMI (1400)
• US Weekly Crude Oil and Product Inventories (1430)
• Switzerland SNB's Roth to Speak (1615)
• US Fed's Yellen to Speak (2130)
• New Zealand Q1 Unemployment Rate and Employment Change (2245)
• Australia Apr. AiG Performance of Construction Index (2330)
• Japan BoJ to publish minutes of April 6-7 meeting (2350)
• Australia Apr. Employment Change and Unemployment Rate (0130)

Market Comment:

The Australian Trade Balance overnight showed a surge to a larger than expected surplus. The two inputs that added up to this outcome were steady commodity exports to China, especially foodstuffs, but a collapse in imports of especially capital goods. So Australia's terms of trade trend is similar to the trend for the United States where a slackening in import demand on weaker consumption is a key factor. But the big difference lies in the two countries' exposure to commodity prices, with the US more vulnerable to commodity price rises due to their dependence on imported oil. Australia only imports a little over a third of its oil and actually exports a third of its natural gas production and is of course a huge exported of thermal coal (for steel production), base metals and foodstuffs - most importantly to China. One thing is for sure - look out below for AUD if China shows signs of stumbling again. The strong Australia Retail Sales continue to show that Australia has experienced less of a consumption meltdown than the UK and the US as credit markets imploded. Still, the Australian economy is hardly likely to escape unscathed: car sales are down over 20% from a year ago, services sector surveys are very recessionary still and the unemployment rate is galloping higher.

Norges Bank lowered rates 50 bps to 1.50% as expected and said it saw rates at 1.00 to 2.00% until its June meeting. The bank gave little guidance, noting some improvements as Bernanke did yesterday, but also noting that inflation pressures seem to be fading. EURNOK has been going nowhere in a hurry. As we have noted before, it is our suspicion that NOK has become a bit more of a safe haven play more than anything else, and the fact that it has managed to tread water versus the EUR could actually be a sign of strength considering the risk willingness evident in nearly every other corner of the market.

The US bank stress test circus continues, with Bank of America at center stage. But in the bigger picture, it seems like we should be moving beyond the financial sector's woes, and injection of a few more tens of billions here and there. After all, if a few more banks need a few more billion, how significantly does it shift the calculus when we've already had the Fed balance sheet expanded by trillions? The focus should and probably will shift to the state of the real economy and its prospects for real improvement from the demand side. The overriding question here is where does demand first stage a real and sustainable recovery?

Today's US ADP employment change (much "less terrible" than expected) should theoretically be a good sign for the US economy as it also shows the "slowing of the worsening" that is evident in other data points, though we would like to see a sustained decrease in the weekly initial claims numbers before we start to look for a reversal in the unemployment rate. The ADP number will put extra focus - and therefore add to the market's reaction - on both tomorrow's weekly jobless claims number and especially the monthly US employment report Friday. For now, the see-no-evil equity market is celebrating the news and the expected weaker USD, weaker JPY reaction is in full swing.

The expectations for the ECB meeting tomorrow are inescapably shifting to the more hawkish side with the tremendous rally in equity markets, easing credit conditions and the much-touted "green shoots" evident in some of the surveys, if not so much in the most recent real economic data in the EuroZone. The most recent batch of ECB comments show too wide a range of viewpoints to indicate that the council will come up with a strong new non-traditional monetary measures. We should look with 95% certainty for another 25 bps of easing to 1.00% with an indication that the council hopes to pause at this level for some time. As for other measures, we might expect some tweaking of existing facilities and the definite possibility that the ECB shies away from new QE-style asset purchases for now. Guidance on asset purchases will be the touchstone issue at this meeting, in any case. Any EUR- positive effect of a more hawkish outcome may be fleeting if risk aversion heads south again as we feel it must soon, as the market may judge the ECB's efforts to be behind the curve and a simple delay of the inevitable.

The BoE may be in a similar dilemma - will it want to announce an extension of it's gilt-buying scheme at this point in time while risk appetite is virtually frothing at the mouth? The BoE is likely to tap very lightly on the brakes relative to its recent meetings, though it will also leave all paths explicitly open. The rate is unlikely to be changed from its current 0.50% at this time. The market already seems to be positioned for this outcome, with risk aversion likely to be the largest risk to the pound at this time, though less so than, for example, the commodity currencies. The market is likely to react very negatively in the short term if the bank surprises with immediate plans to buy up another GBP 75 billion worth of Gilts.

Chart: USDJPY

USDJPY survived an attempted sell-off back below the 200-day moving average after the better than expected ADP number, but the way it has flip-flopped back and forth through this and other key moving averages suggests a very confused market - note also how all of the major MA's are converging here, further muddling the situation. It looks like we need a sell-off through 96.00 or a rally above 100.00 again to get better directional interest. If bond yields continue to edge higher, the side of least resistance will likely be higher.