Employment Optimism Carries Markets Higher
- Employment Reports Confuse, Support Markets
- US Treasury Avoids Confrontation with China
- Euro Falls on German Weakness
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Employment Reports Confuse, Support Markets:
The US dollar and commodity complex continued to strengthen over the weekend as trader grew more optimistic about growth prospects in the wake of Friday's Non-Farm Payrolls report.
The Canadian employment market continued to blow forecasts out of the water, with 69,200 new jobs created in January. Numbers released by Statistics Canada on Friday stated that the pool of available labour expanded by 106,400, increasing the unemployment rate to 7.8% from 7.6% in December. Yields on government instruments jumped as investors raised rate hike expectations, and the Canadian dollar leapt into the 0.9850 area against the US dollar.
The US payroll report itself confused many observers, as statistical methods were changed and different types of data were included. Without getting too far into the technical details, US employers added 36,000 positions, well short of expectations. However, the unemployment rate dropped to 9%, against expectations closer to 9.5. Revised December data showed that payrolls increased by 121,000 instead of the previously reported 103,000.
After an initially negative reaction to the headline numbers, this data was interpreted in a broadly favourable manner in the financial markets. Bond traders moved Federal Reserve rate hike expectations forward, pushing up yields on the short and long ends of the curve. Copper, which has long been considered a proxy for economic activity, rose to a new trading record above $10,100 a tonne in trading on the London Metal Exchange.
Simultaneously, investors worldwide began to retreat from panicky trades as they shifted toward the belief that unrest in Egypt would be contained and crude oil would continue to flow. Front month WTI prices floated down to the $89 mark, while Brent slipped to just above $100 a barrel. The Japanese yen fell on diminished safe haven demand.
Stock markets are also seeing stable trading, with investors broadly optimistic but cautious about pushing rallies too far. The VIX index is now flirting with the 16 level, a post-crisis low. The indicator measures volatility expectations in the equity markets, and is often known as the "fear index". For currency markets, low VIX levels often presage turning points - by definition, periods when expectations are balanced are followed by periods when they are not. Stepping up hedging activities while the markets are complacent makes good sense from a cost perspective (particularly on options products), and from a risk protection perspective.
US Treasury Avoids Confrontation With China:
In a move that surprised no one, the US Treasury Department declined to name China a "currency manipulator" in its biannual report to Congress on Friday. The Treasury is mandated by law to seek arbitration through the International Monetary Fund when it determines that a country is actively manipulating exchange rates. This process carries huge political implications and can set trade negotiations back by years, so is not undertaken lightly.
The report did note that the yuan "remains substantially undervalued" even though the currency has appreciated at a gradual pace since early last year. The currency issue has slipped down the political priority list in recent months as the US economy has improved. Several influential observers have pointed out that high inflation in China is boosting imports and rebalancing economic activity, helping to narrow the current account surplus.
Nonetheless, opposition to China's fixed exchange rate regime remains strong. Democratic Senator Charles Schumer reiterated sentiments that he has expressed for years, saying "it's as plain as the nose on your face that China manipulates its currency. It's just as plain that the only way to address this problem is for Congress to act".
China is the United States' second largest trading partner, after Canada. The US/Canada trade relationship remains roughly a third larger, but the gap is narrowing quickly.
Euro Falls on German Weakness:
The euro slipped slightly after the Economy Ministry in Berlin said that German factory orders had dropped 3.4% in December. While some weakness was expected due to holiday-related inventory rebalancing, the report surprised many traders who had forecast a better result. However, factory order reports are notoriously volatile on a month to month basis. Fourth quarter numbers still point to an ongoing acceleration in the German economy, meaning that the reaction to the headline may blow over relatively quickly.
The euro continues to surprise skeptics. Negotiations about an expansion of the collective rescue fund are ongoing, and some sort of resolution is expected in early March. At the same time, Germany's Merkel and France's Sarkozy are spearheading efforts to further integrate the economies of the European Union. They have proposed a "competitiveness pact" that would hold member countries to a common set of economic principles. Variables such as taxes and minimum wages would be standardized across the common currency zone.
While many countries have already expressed their distaste for these proposals, traders have clearly decided to give Europe's leaders the benefit of the doubt. Short positions on the currency have decreased markedly, and the euro has outperformed year-to-date as investors have flocked back into the debt markets.
Political risks remain, and Chancellor Merkel is facing significant domestic opposition from taxpayers who do not want to be put on the hook for the profligacy of other nations. She appears to have decided that the consequences associated with the potential failure of the common currency project are too dire to contemplate, and is willing to risk her political capital in an effort to support it. Merkel's strength and ideological flexibility have surprised many observers, but as Nietzsche said, "When you stare into the abyss, the abyss also stares into you".
Have a great week – and happy trading!
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