Hopeful week turns sour after disastrous US payroll report; Italy worries

admin11/Jul/2011Currency Updates

Equities and commodities started the week on the same positive note they ended the previous one on, rallying on the somewhat better tone of macroeconomic news out of the United States and the relative dearth of headlines from the peripheral crisis in Europe. Conversely, Governments bonds sold off. All of these moves went into a violent reversal Friday morning. The jobs report surprised even the most bearish expectations – just 18,000 jobs were created and unemployment ticked higher yet again. This dismal report revived doubts about the sustainability of the US recovery, particularly given the headwinds it will continue to face from withdrawal of fiscal stimulus. Risk assets immediately gave back their weekly gains, and the dollar recovered the ground it had lost on the back of a strong flight-to-quality bid.


The main event of the week in the UK was the Bank of England‘s rate setting meeting. However, the gloomy prospects for the economy have removed nearly all the uncertainty over the outcome of these meetings for the time being, and, as expected, the BoE left both the overnight rate and the size of the purchase targets unchanged. We will have to wait for the publication of the minutes to find out whether further monetary stimulus in the form of increased Gilt purchases is gaining traction among MPC members. As for macroeconomic news, May industrial production continued the streak of negative surprises, coming in slightly under expectations and showing a 0.8% contraction YoY. For all the macroeconomic troubles in the UK, at least it lacks the peripheral problems weighting down the euro and held up relatively well, dropping less than 0.5% against the dollar and notching up an impressive 2% gain against the euro.


In spite of the agreement on the second Greek bailout, peripheral woes continue to haunt the common currency. While the key business sentiment indicators continue to hold up relatively well in aggregate terms, the rift between core Europe – Germany in particular, and the peripheral countries is widening, with many indicators in Italy and Spain dipping back into contractionary territory. The Spanish employment report for June was particularly dismal. Meanwhile, the details of private sector participation on the Greece bailout are far from agreed upon. Rating agencies indicated that last week the so-called French proposal of swapping maturing Greek bonds for a complex combination of cash, longer term bonds and other instruments would amount to selective default. The divergence between the ECB (who insists that all creditors, including itself of course be made whole unconditionally) and European politicians (who are insisting on burden sharing by Greek creditors) is getting more contentious. Finally, Italian bonds, which had held up comparatively well during the entire crisis, shot to new highs in spread on Friday amid the generalized flight to quality following the terrible jobs reports in the US. The EFSF facility does not have sufficient funds left to even come close to bailing out Italy.  Given this barrage of negative news, it is if anything surprising how well the euro held up, though it lost about 2.5% against the greenback.


By far the most important data release of the week in the United States was the payroll report. Commentators had relatively high hopes, particularly after second tier employment indicators released during the week had come in better than expected. They were cruelly disappointed by an unspinnably disastrous employment report. Just 18,000 jobs were created, nowhere near enough to even keep up with the natural growth of the US labour force. Unemployment ticked up for the third time in a month, undoing all the year’s progress. The report appears to confirm fears that the US recovery, never vigorous, is stalling. There are some glimmers of hope in the horizon: the supply chain disruption caused by the Japanese earthquake appears to be dissipating faster than expected, and gas prices have dropped considerably from their peaks. However, it is clear that unless the tone of next months’ report changes drastically, the focus will shift back towards further Federal Reserve stimulus, given that the political climate appears to rule out fiscal relief.


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