Cable rises on US payroll shocker
13/Jan/2014 • Currency Updates•
Sterling rose sharply against the dollar in a week that was overshadowed by a very disappointing labour market report out of the US. Job creation fell short of expectations and a drop in the unemployment rate was exclusively due to labour force withdrawal, the kind of effect that the Federal Reserve does not wish to see. This side of the Atlantic, both the Bank of England and the ECB stood pat. We found it interesting that the euro failed to get more traction against the US dollar, as the EUR/USD cross ended the week close to unchanged.
No change in policy or communique from the Bank of England last week. The MPC is clearly on a ‘steady as it goes’ path; further, markets are starting to price in and even earlier exit from zero interest rates than in the US. We remain skeptical, despite the poor labour data released Friday across the Atlantic. Output data in construction and manufacturing were somewhat disappointing, and a gap is opening up between the more buoyant business sentiment indices and the official production numbers, which are released with a considerable lag compared to the former. We think reality lies somewhat between the two, and are expecting a lower-than-consensus 2% QoQ seasonally adjusted annual rate of growth for the fourth quarter. A decent outcome, but perhaps not sufficient to maintain the strong rally in Cable.
The ECB held a remarkably uninformative press conference last week. Draghi said that the ECB is ready to cut rates into negative territory if the inflation outlook worsened, or if tensions returned to the money market. However, it gave no quantitative triggers for either of these developments, so that the information conveyed was almost nil. In fact, the first scenario, worsening inflation outlook, is already taking place. Inflation declined to a new all time low of 0.7% YoY, and the decline was broad based across goods and services. With unemployment firmly stuck above the 12% level, the degree of slack will be sufficient to keep downward pressure on European inflation, which is now the lowest of any major economic area. We think that falling inflation will eventually force the ECBs hand, and expect rates to be cut to negative levels sometime in the second quarter of 2014.
We were no less shocked than consensus by the very weak payroll report out of the US. Only 74,000 jobs were created, although the previous months were revised up a net 38,000. Unemployment fell 0.3% to 6.7%, but it was all due to labour force withdrawal. However, all other first tier data for November came in in the strong side of expectations. The trade deficit narrowed significantly, and it is starting to look as if trade may be a net contributor to US growth on the back of reduced energy imports. We are inclined to regard this weak employment report as a one-off, and wait to see if it is revised away in the next one before drawing any significant conclusions.