Triple Positives in US Jobs

A rare triple positive in US jobs report; strong NFP; strong upward revisions; lowest unemployment rate since December 2008 underlines the improving situation in US jobs, but the disinflationary dynamics in the US and global economy should continue to bolster the arguments of the doves at the Fed. Speculation that Fed dove Janet Yellen will succeed Ben Bernanke will also sway the balance against tapering QE.

Despite this week’s headline-grabbing news in currencies this week (potential for negative Eurozone rates and possibility for Fed to raise asset purchases), the tug of war between the two most liquid currencies implies continued consolidation in EUR/USD between the 1.2900-1.3200 range.

Draghi’s “Negative Rate” remarks are more Talk than Action
Draghi’s reference to negative deposit rates is seen more of a verbal jawboning of the euro in the event of another euro rally resulting from the Fed’s weighing of more asset purchases, rather than an actual statement of intent.

The ECB cannot afford to penalize member banks via negative deposit rates as it will encourage hoarding of cash. This also unsuitable for a region where banks are required to raise capital.

Sharpening Divergence Between Market & Macro Metrics
The ECB’s rate cutting decision was all about addressing the economy, rather than liquidity conditions. The decline in Eurozone CPI to 33-month lows (the biggest monthly point-drop since July 2009), the dual contraction in Germany’s manufacturing and services sectors, the seveth quarterly growth contraction in Spain as well a new record unemployment rate of 26.7% are all in contrast with three-year lows in Spanish and Italian yields, a stable EURIBOR and a steady currency.

These deteriorating macro factors imply inevitable currency jawboning rhetoric from ECB and govt officials (especially the election-bound Merkel) in the event of excessive euro appreciation. Fears of a German double dip will likely escalate after Germany’s Q4 GDP q/q was -0.6%.

Fed QE to remain unchanged, before increasing in 2014
We never subscribed to the notion of “tapering” QE by the Fed for a number of reasons:

-       The projected loss of 2 million jobs and a decline of 0.6% in US GDP from the sequester is a significant contraction of economic activity

-       Consumer and business sending cannot make up for plummeting Federal spending when asset markets decline as a result of falling QE

-       The increasing threat of disinflation is overshadowing any fears of inflation, giving the US and other central banks little choice but to stick with asset purchases

More Downside for Commodity Currencies
With all 6 metals down on the year and energy prices being the only group in the green, the commodity currency story has more downside ahead.

Canadian Dollar faces More Downside
The appointment of the head of Canada’s export agency to the helm of the Bank of Canada means that Canadian exporters will finally find an ally at the central bank. Stephen Poloz is likely to be more attentive to the needs of exporters via capping the Canadian dollar, which was not the case with Marc Carney. Renewed weakness in the US and shaky outlook for Canadian banks will lead the Bank of Canada in reducing its hawkish stance to the detriment of the currency. Expect USD/CAD nearing 1.03, followed by 1.0500.

Aussie Downwside far from done
Deteriorating Aussie employment figures (four-year high unemployment rate) and broad deterioration in business surveys will add to the deterioration in the currency. And while there is no Chinese hard landing, don’t expect any notable recovery either, which will weigh on Aussie prospects. Finally, with Japan’s Asian trade feeling the pinch from the falling yen, their cooling economies will be another factor weighing on the Aussie. Expect AUD/USD back to parity from current 1.0300.