For the second month in a row, U.S. companies added fewer jobs than the market had anticipated but this month the initial losses in U.S. assets from the U.S. dollar to the S&P 500 were recovered quickly as investors focused on the bright spots in the labor market. Only 113k jobs were created in January compared to the market’s 180k forecast but the unemployment rate continued to fall while average hourly earnings and the labor force participation rate increased. The monthly payrolls report can be volatile and the fact that job growth increased at all is a positive sign for the economy. Over the past 6 months, the U.S. is still adding an average of 177,500 jobs per month. While this is hardly indicative of strong growth, the data is also not terrible enough to alter the Fed’s taper plans. The 0.2% increase in average hourly earnings and the labor force participation rate signals that existing workers are making more money and this dynamic is encouraging people to return to the worker force. The broader and more reliable U6 unemployment rate also dropped from 13.1% to 12.7%, its lowest level since November 2008.
The main takeaway from Friday’s labor market report is that the U.S. economy continues to recover, albeit at a slower than anticipated pace. In some ways, this is good news because it means that the Federal Reserve won’t taper asset purchases too quickly. Instead, they may have to consider ways to amend and strengthen forward guidance as the unemployment rate approaches their 6.5% threshold. The jobless rate now stands at 6.6% but the pace of job growth has not been strong enough for the central bank to speed up the removal of stimulus. So Janet Yellen will need to decide whether to lower the threshold or drop it completely like Fed President Lacker suggested earlier this week. He said the central bank “will have to reformulate and provide some qualitative way of providing an assessment of what time horizon we think is most likely” for rates to start rising.
Our first opportunity to get Yellen’s interpretation of the data is next week when she delivers her very first semi-annual testimony on the economy and monetary policy. She is scheduled to testify before the House on Tuesday and Senate on Thursday. Her prepared remarks will be released at 8:30am ET on Tuesday, 90 minutes before she delivers her first public speech on the economy as Chairman of the Federal Reserve. There is no doubt that she will be asked about what the Fed plans to do with their 6.5% unemployment rate threshold and most likely she will say that they will reevaluate the forward guidance in March. Yellen’s testimony will be the most important event risk on the U.S. calendar next week but retail sales will also be very important. Consumer spending is expected to stagnate after growing only 0.2% the previous month. Weak demand is another challenge that Yellen needs to address early in her term.
U.S. monetary policy won’t be the only focus of the foreign exchange market in the coming week. The Bank of England will also release its Quarterly Inflation Report and like the Federal Reserve, their backs are against the wall because the unemployment rate is falling faster than they anticipated. The BoE also tied itself to an unemployment rate threshold and they are now only 0.1% away from that level. Unfortunately the recovery in their economy is not strong enough to handle an increase in interest rates, which they promised would be their first step in unwinding stimulus. Aside from providing their latest economic forecasts, the Monetary Policy Committee has oftentimes used the Quarterly Inflation Report to telegraph major changes in policy. They will need to update their forward guidance this quarter and they could either choose to abandon their unemployment rate threshold or lower it. We think tying monetary policy to the jobless rate was a big mistake for U.K. and U.S. policymakers and both should abandon this rule completely and move to something more qualitative to manage the market’s expectations. This option would create less volatility for their financial markets and the currency than a change in the level of the threshold. Friday’s industrial and manufacturing production numbers confirm that now is not the time for the BoE to tighten monetary policy. The recent slowdown in manufacturing and service sector activity is a sign that the economy still needs support. Sterling traded higher but a continued recovery will hinge upon optimistic comments from the central bank.
The rally in risk drove the euro higher against the U.S. dollar for the third consecutive trading day. Weaker than expected trade activity in Germany and France along with the German Constitutional Court challenge of the ECB’s OMT program should have been negative for the currency and it was up until the U.S. non-farm payrolls report. Euro shot higher after NFPs and when the initially volatility settled, it held onto its gains throughout the North American trading session. A further rally in the currency next week will hinge on the tone of Janet Yellen’s testimony because no major Eurozone economic reports are expected until the end of the week when fourth quarter GDP numbers will be released. 2013 was a tough year for the Eurozone with no major acceleration in growth at the end of last year. Meanwhile according to our colleague Boris Schlossberg “The German Constitutional court challenged the constitutionality of ECBs OMT program but did not rule it illegal, passing the final judgment on to the European Court of Justice in Brussels. The EUR/USD initially tumbled on the news dropping to a low of 1.3550, but quickly found its feet and settled down in morning London dealing. Many analysts pointed out that the OMT has never been used and is unlikely to go into effect anytime soon. By referring the matter to ECJ the German court implicitly acknowledged the superiority of Brussels to Berlin and ceded sovereignty on the matter. The ECJ is expected to take a more liberal view of the matter and will likely rule in favor of the program.”
Better than expected employment numbers drove the Canadian dollar higher against all of the major currencies. After seeing 44k jobs lost in the month of December, Canada regained 29.4k jobs last month. This helped to drive the unemployment rate back down to 7% from 7.2%. What made the report particularly encouraging was the fact that Canada recovered nearly all of the full time jobs lost at the end of last year. Full time employment rose 50.5k while part time employment declined by 21.2k. Friday’s report was a breath of fresh air for Canada and is a sign that economic conditions improved in January after slowing at the end of last year. The data also shows that the improvements we saw in the manufacturing sector earlier this week translated into stronger hiring. Profit taking could drive USD/CAD down to 1.10. The New Zealand dollar also rebounded against the greenback but the Australian dollar ended the day unchanged. Slower construction sector activity in Australia and weaker Chinese service sector activity weighed on the currency. Most of the changes made in the Reserve Bank of Australia’s Quarterly Monetary Policy statement were the same as the last RBA statement. The central bank raised its inflation forecasts and said the level of the currency is consistent with balanced growth in the economy which suggests that they believe that the lower A$ is contributing to higher price pressures. We continue to believe that the Australian dollar will see further gains given the shift in the RBA’s bias as short positions in the AUD/USD are unwound. According to the CFTC, traders reduced their short AUD positions but continue to hold massive amounts. There is no major Canadian or New Zealand data schedule for release in the coming week but Australia will release its employment report.
The improvement in risk appetite drove the Japanese Yen traded lower against all of the major currencies Friday. Japan’s economy continues to recover with the leading index rising to 112.1 from 111 and the coincident index rising to 111.7 from 110.7. Both reports beat expectations and lent support to the rally in Japanese equities. There is an election in Tokyo this weekend and Masuzoe who has the support of Prime Minister Abe is widely expected to win. If his opponent Former Prime Minister Hosokawa steals the election for whatever reason and becomes the new governor, the Nikkei could sell-off, driving USD/JPY lower. Meanwhile the introduction of the Nippon Individual Savings account has also been a big boom for Japanese equities. These are small tax free investment accounts designed to encourage the Japanese to take on more aggressive investments. According to the Tokyo Stock Exchange, Japanese investors bought the largest amount of domestic stocks on a weekly basis since the exchange started keeping data in 2005. This could explain why Japanese investors have been selling foreign bonds, because they are reinvesting some of those funds domestically. According to the latest CFTC IMM report, speculators continue to hold massive short yen, long dollar positions but their exposure was reduced over the past week.
Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
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