US Dollar Driven Higher
US dollar gains have been extended for the third session. The euro has been sold down to almost $.1.30 after testing $1.33 on Wed. More stale longs may be forced out on a break of $1.2985, which corresponds to a 50% retracement of the advance from the mid-Nov low near $1.2660 and the 50-day moving average.
Sterling's decline is even more dramatic. It has come off hard since setting a 17-month high on Wed near $1.6380. It has now been pushed below $1.6040, which the 61.8% retracement of its rally from mid-Nov low near $1.5830. Sterling has also slipped below the 50 and 100-day moving averages for the first time in seven weeks.
The main data in Europe was the service sector PMI. The headline confirmed the five month high of the 47.8 flash reading. However, both the German and French reading came in below their flash reports. Germany at 52.0 rather than 52.1 and France at 45.2 rather than 46.0. The counter-balancing upside surprises came from Italy (45.6 up from 44.6 in Nov and 45.0 expected) and Spain (44.3 from 42.4 and forecasts of 42.8). Yet even this should be kept in perspective. Spain and Italy headline service PMI have not been above the 50 boom/bust level for more than a year.
The UK's CIPS service PMI was as large a disappointment as the manufacturing PMI earlier in the week was a pleasant surprise. The 48.9 reading contrasts with forecasts for 50.5 and the 50.2 reading in Nov. It is the fourth consecutive month in which the headline has been lower. New business is at a two year low. The risk is that after the expansion in Q3, the UK economy contracted anew in Q4. At the same time, preliminary reports suggest the funding for lending scheme is easing the supply of credit and fear that the UK suffers from weak productivity more than the lack of aggregate demand (which could make further easing more inflationary than stimuluative, a la the BOE's Weale) means that there is unlikely to be a policy response to the new evidence of economic weakness.
Meanwhile, the greenback has pushed to new highs against the yen, moving above the JPY88 level in late Asia and holding above it in the European morning. The Nikkei re-opened for the first time in the new year to post a strong 2.8% gain. Japanese government bonds slumped with the 10-year yield rising almost 4 bp to 0.825%, the highest level in more than three months.
The 30-year bond yield rose to almost 2%, its highest level in more than a year. Yet, given the magnitude of the yen's decline and prospect for more to come, and the policy thrust of the new government, it is surprising yields have not risen more. Japan will auction a total of JPY3 trillion of 10- and 30-year bonds next week and some of the weakness today may be related to deal position adjusting
Many market participants seemed to emphasize the wrong part of the FOMC minutes. The key take away is not that there is some disagreement among the members about the duration of QE. Instead, the key point is that the Fed is committed to expanding its balance sheet by buying more than $1 trillion of MBS and Treasuries in 2013 ($85 bln a month). We note that from the Fed's perspective, the stock of its holdings of long-term assets is the key to its effective not the flow of purchases.
Moreover, its macro-economic guidance indicates that in will not raise interest rates until after unemployment falls below 6.5%, provided core PCE stays below 2.5%. Plugging these macro-economic conditions into a Taylor-like model underscores the dovishness of the Federal Reserve. On top of that, the composition of the FOMC, with new regional presidents rotating, tilts a bit more in the dovish direction.
The economic highlight of the day is the US jobs report. In addition to the usual acknowledgements that this is among the most difficult high frequency data points to forecast, we share the following observations: 1) Many revised up their estimates following the stronger than expected ADP report. This means the 150k consensus is probably on the low side of expectations 2) Initial jobless claims during the survey period were a little higher and small business survey was cautious. ISM for manufacturing rose back above 50. 3) ADP is not a good predictor on a monthly basis, though it tracks trends fairly well. 4) This is especially true for the month of December, where ADP has over-stated the first BLS estimate by an average of almost 150k in the past two years. 5) Uncertainty surrounding the fiscal cliff did not seem to weigh on hiring decisions. Private sector job growth in in the Sept-Nov period was essentially no different than the prior three month period. 6) Net private sector job growth averaged about 151.5k in the first eleven months of 2012. This compares with 153k monthly average in 2011.
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