Once again, the latest US jobs numbers were, at first glance, better than expected with a significant upward revision in the annual benchmark review also adding a supportive tone to the data. The reaction of the dollar has been understandable, the dollar index up 0.5% on the perception that further QE is now less likely.
Furthermore, both November and December jobs growth were revised higher by 60K, and the unemployment rate fell to 8.3%, the lowest reading for nearly three years. Of course, for some this sits uncomfortably with the Fed’s pledge to keep rates close to zero for nearly the next three years. Video:
Looking at the bigger picture however, and on closer examination of the data, it’s not that difficult to square the circle. Firstly, there is the state of the labour market so far during this recovery. Whilst the economy may have passed its pre-recession peak in output, the labour market still has to see employment expand another 4% on the payrolls measure to achieve the same. The other stand-out feature of this report is the sharp fall in the participation rate, the largest monthly decline for just over two years, although this was down to the population control effects from the annual revisions.
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What they are showing is that just 63.7% of the working age population is either in work or looking for work. So whilst this report has been positive for the dollar and painted a decent picture of the labour market relative to where we thought it was beforehand, it should be considered in the context of the overall recovery and the extent of labour force participation.
The latter remains particularly disappointing and goes a fair way to explain the stagnation of median incomes over the past decade. The closer the US gets to the presidential election the more short-termist politicians will become in relation to these the numbers.
Commentary
More UK QE despite stronger data. Last week’s UK data has muddied the water surrounding this Thursday’s MPC meeting, when the Bank of England will be debating the merits of further quantitative easing. In the wake of the Q4 GDP numbers (which fell 0.2% QoQ), the immediate fear was a return to recession, given that the last quarter of negative growth (Q4-’10) was easier to dismiss as the result of one-off factors. On Friday, the services PMI for January rebounded to the strongest reading for ten months, surprising to the upside for the third consecutive month. A similar pattern has been seen in the manufacturing series, although in absolute terms it remains lower than the services series. As of a week ago, the Bank of England had GBP 6.4bln of gilt purchases remaining to be implemented from the additional GBP 75bln of asset purchases previously announced. Our blog of last month, looking at the impact of QE so far, suggested it had been less than the first round, naturally adjusting for the lower size of purchases in this second bout (see ‘The inefficiency of QE2 in the UK’). The tentative evidence since then suggests little has changed. The premium of Gilts over German paper has been on a widening trend (just as much down to the safe-haven appeal of German bunds). Meanwhile, at the other end of the interest rate curve, we’ve seen sterling Libor spreads over overnight swaps (the broad benchmark of banking sector stress) widening, in contrast to the narrowing seen in the US and more so for the eurozone (largely thanks to the ECB’s 3-yr repos). Furthermore, the BoE’s own data on effective interest rates (those charged to households and companies) shows only a modest fall between October and December. Overall, given the ongoing uncertainties about the economy, and some better signs on inflation since the November Inflation Report, we suspect that the BoE will sanction more QE later this week (at most GBP 50bln).
Japan rattles the cage on the strong yen. Policy-makers in Tokyo are writhing in discomfort over the latest pop in the Japanese currency, with USD/JPY down to 76.60 from nearer 78 a week ago. Japanese Finance Minister Azumi has weighed in, claiming that it is partly the fault of the Federal Reserve for the recent advance. He also suggests that it reflects “short-term speculative buying”, although this assertion is inconsistent with trader-positioning reports such as the CFTC. More likely is that some investors have been buying the yen as a safe-haven amidst continuing concern over the uncertain situation in Greece and Portugal. Other safe-havens such as gold, US treasuries and the Swiss franc have also strengthened recently. With an enormous war-chest of intervention money at its disposal, there is an understandable reluctance to try the MoF’s patience, especially now that its frustration is becoming public again. Exporters continue to bleat loudly about the damaging impact of the strong currency, with many threatening to move their operations offshore. It is most certainly the case that producers have been relocating production for quite some time, simply because it is too expensive and uneconomic to manufacture in Japan. At the same time, policy-makers would be conscious of the criticism levelled at them by the US Treasury back in December. Last year, BoJ intervention was almost USD 200bln, the third largest in its history. Despite the yen’s strength, the economy this year is expected to grow by a respectable 2%. In the near term, it is likely that traders will, very slowly, put the MoF to the test in terms of the point at which it is prepared to instruct the BoJ to intervene. As such, we may see the yen get just a little stronger against the dollar in coming weeks.
Iberian intent. In sharp contrast to Greece, it is difficult to be too critical of the intentions of politicians on the Iberian Peninsula. Portuguese Prime Minister Pedro Passos Coelho has implemented significant austerity measures designed to lower the budget deficit to 4% of GDP this year, against the headwind of another deep recession, and debt-to-GDP is expected to stabilise at around 112% in 2013. He has also vowed to undertake a second round of asset sales, reinforcing his commitment to fiscal prudence. Unfortunately, after S&P’s recent decision to chop Portugal’s credit rating to below investment grade, numerous banks and real money managers were forced to sell their exposure to Portuguese debt. This resulted in a very sharp sell-off in Portuguese debt, with the 10yr yield reaching 18.4% earlier this week, now 14.7%. It could be argued that investors in Portugal are over-reacting; because of last year’s EUR 78bln rescue, Portugal is basically funded until the end of next year. Likewise in Spain, PM Rajoy is focused on reducing debt and deficits as well as implementing much-needed structural change. In a bold move yesterday, Economy Minister de Guindos announced that banks would be given a further year to write down their bad real-estate loans if they agree to merge by May. They would also gain access to the government’s bailout facility. De Guindos stated that banks would be forced to raise provision on loans for urban and rural land to 80%, from 31% currently. Although this announcement will not affect the budget deficit, it will raise debt because the Spanish treasury will need to issue bonds so that the equity in the bank bailout fund can be raised to EUR 15bln from EUR 9bln. Together with Italy, Spain has been given the benefit of the doubt over recent weeks, no doubt helped by the ECB’s generous 3yr LTRO. Two months back the 10yr yield was up at 6.75% whereas today it is below 5%, the lowest since November 2010. For a no-growth economy, a 5% yield is still too high. However, it is clear that some investors and banks have been prepared to dip their toes into Spanish bonds over recent weeks. Financial conditions on the Iberian Peninsula remain extremely fragile. Just possibly, however, there may be a light flickering down the tunnel.
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