Chef's Special: Disappointment

Disappointment may be served up as the chef's special today Market expectations are at risk of getting ahead of themselves on the two main events today, the US jobs data and the EU Summit. Nearly every economic report showed an improvement in the US labor market, including both ISM reports, Challenger report, weekly initial jobless claims and details in consumer confidence reports.

However, there are two factors that many observers may be under-appreciating. First, the weather was poor and the other time series may not have picked it up and many economic forecasting models may not have been a sufficient adjustment. Admittedly it is difficult to forecast the impact of the winter storms, but a conservative estimate may be around 30k. Second, there seems to be a quirk in the January time series beginning in 2004 and may be related to the birth/death adjustment the BLS uses to account for employment changes at small business. The January nonfarm payrolls report has disappointed in each of the past seven years.

The market may also be disappointed with the EU Summit. While numerous proposals have been aired, profound disagreements remain, and even between France and Germany. The EFSF is the center piece of the efforts, but Germany is fighting a rear-guard action to return the EFSF to its original function to buy sovereign bonds.

Although few are comfortable with the ECB buying sovereign bonds, Germany is apparently concerned about the lack of conditionality if the EFSF were to buy peripheral bonds. Moreover, Germany's ability to influence the agenda is at its strongest in the negotiating phase, not post-agreement. The reforms it is seeking are likely to be seen as too onerous for many countries, like a harmonized corporate tax rate and minimum retirement age, and national law/constitutional changes to more firmly establish the Stability and Growth Pact.

The disappointment anticipated here is only one part of the story. The price action is a horse of a different color. The market may look past the disappointment in the US jobs data, but as Bernanke stressed yesterday, the labor market recovery is going to take a couple of years. Yet it has begun. First the layoffs slowed, then the job creation began. Private sector jobs grew each month last year and at an average past of 112k. The Q4 average was slightly faster at 128k. As we have noted, the increase in the work week has also added full-time equivalent jobs.

At the same time wage growth has been slow and this constrains incomes and consumption. The market appears to expects the $600 bln of Treasury purchases under QEII to be completed. Disappointment with the absence from European officials may be more difficult to look past immediately because of the large position adjustment that has already taken place and that next big event for Europe is not until the late March summit.

The dollar has been confined a little less than a 1 yen range against the Japanese currency this week. Interest rate differentials, for which we find the dollar-yen rate is often sensitive to, have moved sharply in the US favor--about 15 bp across the coupon curve. This is likely to lift the dollar in the near-term. However, there is another interesting story today from Japan that is potentially important for asset managers: Japan's number 1 and 3 steel companies (Nippon Steel and Sumitomo Metal Industries are merging.

This will produce the world's second large steelmaker. It appears to be one of the largest non-bank mergers in Japan. It is being driven by competitive pressures and need to secure greater economies of scale. Chinese and South Korean steel producers in particular are squeezing Japanese producers. Industries suffering from excess capacity, like steel, are vulnerable to consolidative pressures. With investment banking reviving, corporates flush with cash, look for more economic rationalization.