ECB Post-Mortem and US Jobs

The US dollar has surrendered around half of yesterday’s gains as European investors, more so than Asia, seemed to look past the drag from Draghi and anticipate a stronger European response next month and a jobs report that will keep the Federal Reserve looking to provide more support. Asian shares finished lower, ostensibly hurt by the decline on Wall Street. The Nikkei’s 1.1% decline was also spurred by poor Sharp and Sony earnings. The 1% gain in the Shanghai Composite was encouraged by news that government was reducing a transaction tax on equity securities, ironically just as several countries in Europe introduce a financial transaction tax. 

China’s non-manufacturing PMI slipped to 55.6 from 56.7. News that Chinese officials are warning a more cautious stance in terms of mining deals undermined Australian shares, sending local shares down a little more than 1% and reversing of the week’s modest gains. European bourses, like the euro itself, has recouped are half of yesterday’s losses, with the Dow Jones Stoxx 600 is up about 1.25% near midday in London, led by a 2.5% rally in financials. 

Despite the disappointment with the lack of substantive action from the ECB, Spanish and Italian bonds staying a modest recovery at the long-end, but Draghi’s indication ECB operations would be focused at the short-end has seen a more dramatic response in the 2-year sector. Spain and Italy’s 2-year yields are off 48 and 54 bp respectively. Note that Moody’s cut Slovenia’s rating by three notches to Baa2 late yesterday, increasing the likelihood it too will see assistance.

The major foreign currencies are well bid in Europe, but the technical indicators warn that additional strong gains are unlikely ahead of the weekend. The euro is likely to meet resistance in the $1.2250-80 area. Similar resistance in sterling is seen in front of $1.5600. The Australian dollar has been capped near $1.0540 for the past four days, except for that brief spike to $1.0580 yesterday. The dollar’s shelf near JPY78.00 remains intact and uninspiring. 

Today’s euro area data does little to alter investor perceptions that the euro zone remains mired in contraction/stagnation. The euro area non-manufacturing PMI came in at a 4-month high of 47.9 vs the 47.6 flash reading and 47.1 in June. The composite reading rose to 46.5 from 46.4. Retail sales in June rose 0.1% compared with consensus expectations for a flat reading, but the year-over-year contraction accelerated to 1.2% from -0.8% in May. The UK CIPS Service PMI was a bit disappointing at 51.0 from 51.3 in June. This is the lowest reading since late 2010. This follows the poor manufacturing survey earlier in the week. Although much focus is on the Fed and ECB, the BOE is also like to come under greater pressure to extend its gilt purchases and cut rates. 

The US employment data is the last major event in what has been an eventful week. Of the numerous high frequency time series, the US nonfarm payroll report is among the most difficult for economists to forecast. There are very few inputs that are reliable. The weekly initial jobless claims, the ADP estimate and the surveys, like the ISM, can be vaguely helpful in the general direction, but the discrepancies in any month can be significant. 

Given the easing bias that we argue the Fed has in effect adopt, perhaps how the data compares to the recent trend, rather than how the report compares with expectations may be more important. Consider that private sector job growth averaged 91k a month in Q2, which is the lowest weakest quarterly average since Q1 2010. March 2010 was the first month since January 2008 that the US economy grew private sector jobs. The Q1 ’12 monthly average was 226k and in Q4 ’11 the average was 183k. We anticipate some stabilization now at lower levels. Private sector job growth of more than 85k in July will see the 3-month moving average increase. 

However, anything below 100k will be disappointing. In any event, even 100k though is sub-par and will not dissuade market participants from expecting the Fed use its balance sheet to support the fragile expansion. The jobs data will set the tone for other economic reports during the month, including industrial production and manufacturing output, construction spending, and personal income and consumption. 

Many observers blame Germany for preventing the ECB from taking bolder action. We demur. The German board members have been outvoted before. Instead, it seems that Spain’s refusal to formally request the EFSF to support its bonds is the main culprit. 

This is not to say there are not Rajoy does not have good reasons. A public request could trigger a sharp increase in Spanish yields and EFSF buying bout not happen immediately and some countries, like Germany, would have to approve.  Moreover, the conditions that would be attached and the stigma associated could also be destabilizing. Press reports suggested that Italy’s Monti was encouraging Rajoy to make a formal request. The pressure can only mount going forward as the ECB works on designing what Draghi called “appropriate modalities” for a policy response.