Friday's Thoughts and Seven Investment Themes

The US dollar is softer ahead of the employment report, but largely within yesterday's ranges, which themselves where inside Wednesday's ranges for the most part. Prior to the jobs report, the euro is the weakest G10 currency, off about 0.4%. The strongest has been the New Zealand dollar, up 0.7% and the British pound up 0.65%, followed by the yen which is up 0.55%.

Sterling has been aided by yet another upside economic surprise. The service PMI rose to 56 from 54.0 and defied expectations for a decline. It is the thirteen months above 50 and is the best since last March. This follows the stronger than expected manufacturing survey earlier this week. Nevertheless, the BOE should still be expected to announce a new round of gilt purchases next week. At 50.4 the euro zone service PMI was in with the flash (50.5) after the 48.8 reading in December, which is a 5 month high and the first reading above 50 since August. France was tweaked up and the flash German reading tweaked down. The ECB meets next week and it is most likely to stand pat.

There is downside risk to today's US employment data. First there is the unwinding of the holiday-inspired gains seen in December and this is worth about 45k. Second, the seasonal plug factor also points to downside risks. Third, the ADP, Conference Board and ISM point to slower job growth.

Separately note that the annual benchmark revisions in the household survey will also be released today and that will shed light the trajectory of the labor market. Although disappointing economic data may be associated with a risk off market reaction. It will be important to see if this pattern holds, or whether the "threat" of QE3 sees the dollar sell off on disappointing data.

Canadian jobs data was a major disappointment but offers little insight into the US report. Canada grew 2.3k jobs rather than 22k as the consensus expected and that was only possible because part time jobs offset the loss of full time jobs. The Canadian dollar eased in response but the US data is seen as more critical to the near-term direction.

Lastly, a few themes are shaping the investment climate here in Q1. First, trajectory of monetary policy in the US, Europe, China and Japan is in a more accommodative direction. Second, the underlying economies are showing preliminary signs of stabilizing. Third, the combination of easing monetary conditions and economic stabilization has boost demand for higher risk assets. In addition to major equity markets, emerging markets off to a strong start. Funds that exited the emerging markets in Q4 11 return. This has helped fueled currency and asset (bonds and stocks) appreciation.

Fourth, as a consequence, intervention to support local currencies (which means selling dollars) has slowed and this is allowing re-accumulation of reserves. Fifth, in recent past reserve diversification has favored the euro, but there is increasing market talk that of reserve managers reducing euro exposure. Sixth, these developments taken together have generated lower volatility in the global capital markets. Seventh, these forces may seem well entrenched, but the risk is that volatility is coiling like a spring, leaving the market vulnerable to reversals on disappointing news.