Strong US Employment Data Can’t Distract European Fears

The big news of the afternoon has been the whopping ADP employment number. We all knew the US was getting stronger, but we didn’t expect the private sector to create 325k jobs last month. This was 8 standard deviations bigger than the 177k estimate and was the largest monthly gain since December 2010. The gains were mostly in the services sector, construction also increased although financial services saw a decline of 1,000.

The report was encouraging since it showed strong gains especially for medium and small companies with less than 50 workers. The market reaction was an immediate spike higher for risk, however, it hasn’t managed to have a prolonged effect and EUR/USD looks vulnerable as it tests support at 1.2800.

The markets won’t be convinced about the state of the US labour market until the payrolls figure is released on Friday at 1330GMT/ 0830 ET. The correlation between ADP and payrolls is virtually nil, so investors are right to temper their jubilation on the back of this number. Added to this some large US companies including Pepsico have announced job cuts in recent days so a strong recovery in the labour market may not be sustained.

There was another steady decline in the number of people registering to receive jobless benefits as initial jobless claims came in at 372k below the 387k from the week before Christmas. This has pushed the 4-week moving average down to 373,250 from 376,500 the week prior. We doubt that the US labour market is as strong as the ADP number suggests, instead the steady improvement in the jobless claims data is a more accurate representation of, in our view, an economy that is improving slowly, but surely.

This was also reflected in the ISM non-manufacturing survey that was released for December this afternoon. This was stronger than November at 52.6; however it was below expectations of 53.0. The detail of the report was also fairly good with moderate gains for the employment and new orders components, although export orders, backlog of orders and inventory all fell last month.

The labour market data hasn’t been enough to boost the US stock market, which opened lower today. Fears emanating out of Europe continue to dominate the markets and is weighing heavily on the euro, which has been falling continually throughout the London session and is currently below 1.28 for the first time since September 2010. The next support of note through here is 1.2670 – the lows from August 2010.

The problems in Europe are coming from all directions: Spain, where the economy minister said that banks will need to accumulate EUR 50bn more capital to cover future loan losses, the banking sector, which needs to raise capital but can only do so if it issues new shares at a steep discount, which in turn causes bank share prices to drop even more, and Hungary. The Eastern European nation is fast becoming the Greece of its region after it had a near failed bond auction today and rapidly rising bond yields. But why does this country matter? Because of Austria, of course.

Austrian banks have exposure to Eastern Europe to the tune of EUR 200bn, mostly through foreign currency mortgages that are getting harder to pay for now that the Forint is falling through the floor. Although the Hungarian government set up a programme to help with foreign currency mortgage burdens, the sovereign finances are also under pressure and the government failed to sell all of the debt it wanted to at an auction today. This makes it more likely that Austrian banks could get hit with rising bad debt levels, possibly requiring state support thus weakening Austria’s public finances possibly putting the ECB on the hook for Hungary as well. The Hungarian government is still in talks with the IMF and EU to secure a fresh bailout, the second after it received its first in 2008, however if it can’t secure new funds then we could see Hungary default. Hence Austrian 10-year bond yields are much higher today, rising more than 40 basis points in the last 2 days.

So Hungary is another cog in the massive wheel that is the Eurozone that is dominating market sentiment right now and causing a fresh round of market despair. Interestingly, the Dax rallied on the back of the stronger US data. Since Germany is such a large exporter a strong US is good for German companies. Also, Europe tends to follow the US’s economic cycle, albeit with a lag, so a strong US could rub off on Europe’s economy later this year.

The head of the Swiss National Bank Hildebrand is talking, however we expect him to be grilled more on his wife’s currency trading than on the EUR/CHF peg. The Swissie is fairly stable at the moment, but is at risk of appreciating if he was to resign in light of this crisis since the Swissie would attract safe haven funds. Due to this, EUR/CHF could be volatile in the coming hours and days.

Europe is on everyone’s mind and has even nudged the US jobs market out of the limelight (until Friday anyway). There aren’t many events in the immediate future that could calm nerves as investors await Italian and Spanish bond auctions next week, so expect a rocky end to the week.