Services, Jobs and Politics Dominate FX

There are three main considerations in the foreign exchange market today.  The weaker than expected euro zone services PMI, the US jobs report and that spate of European elections.  The US dollar is slightly firmer, but largely within yesterday's ranges. 

There is nothing good that can be truly said of the euro zone service PMI.  It fell sharply and the slide accelerated since the flash.  The April reading was 46.9.  The flash was 47.9 and the March final was 49.2.  That gap between the flash and the April reading was the biggest since October 2008.  The service sector news follows the poor manufacturing PMI earlier in the week and produces a composite of 46.7 vs 49.1 in March.  

Germany and France both deteriorated from the flash readings.  It was not simply picking up the weaker peripheral performance.  Germany reported 52.2 form 52.6 flash and 52.1 in March.  And that is the best.  France went from 50.1 in March to 46.4 flash reading and 45.2 today. 

The weakness in Spain and Italy is simply frightful.  Spain stands at 42.1.  The consensus expected 45.1.  In March it was 46.3.  Italy stands at 42.3 vs expectations of 44.0 and a 44.3 reading in March. 

Sweden, for sure not part of the euro zone, is also being adversely impacted.  Its PMI fell for the first time in five months to 48.6 from. 

The bottom line here is that the European economies are off to a very poor start for Q2.   The key to the monetary policy response in Europe, as in the US, is not simply data dependent, but data dependent relative to official expectations.  As Draghi noted yesterday, the ECB will provide new growth and inflation forecasts in June.  In March, the last forecasts, revised this year's GDP forecast to -0.1% from 0.3%.  A further downward revision would spur expectations for a policy response. 

The UK local elections may give a taste of what the weekend holds.  Reports indicate that the Labour was the significant winner, taking council seats from the Tories and Lib-Dems.  The latter appeared to have their worse showing since the party began in 1988.   The Tories may hold on to mayor's office in London. 

To the extent that the Labour vote was a protest against the Tories then it may be a harbinger of this weekend's elections in France, Greece, Germany and the Italy.  It is tempting to suspect that the likely outcomes--Hollande victory in France, fragmented government in Greece, another defeat for the FDP in Germany, and a protest vote against Monti in Italian municipal elections--have already been discounted.  Yet the political uncertainty mutates from the electoral outcome to the commitment of future leaders in the Berlin Consensus that centers on fiscal reforms. 

Expectations for US employment have liked been shaved in the aftermath of the ADP report.  It probably  requires a reported below the March 121k increase in the private sector to new news at this juncture.  Note though that the layoffs from the government sector has added to the impression of the jobless recovery.  Although the US does not have a consolidated corrective fiscal strategy, the government sector has been a big drag on GDP. 

Consider the performance over the past couple of quarters.  The private sector has expanded by about 4% while the public sector has contracted by nearly the same amount.  This produces overall growth of about 2.5%, which, while within the Fed's expectations, is not seen as faster enough to absorb the excess capacity--or close the output gap in a timely way.  

One of the factors that will hold back the job creation is the seasonal adjustment that goes from tailwind to headwind.  But that is not the only factor slowing the economy.  Production was running ahead of demand and output has to be brought back in to line.  However, as the auto sales earlier this week illustrate, demand continues to hold in.  

Boeing's report yesterday also reveals a non-weather induced source of pressures.  After a very strong Dec-Feb period, the inevitable slow down is at hand.  It reported only 4 orders in April, down from 53 in March and almost 240 in Feb.  This warns of a sharp fall in durable goods orders and factory orders.  Exports may fare better as Boeing exported 33 planes in April after 37 in March.