Subdued Markets Amid Light News Stream Ahead of US Employment Report

The US dollar has traded in narrow trading ranges in Asia and early European activity. Many think that the focus is the US jobs report, but outside of a knee-jerk reaction to the headline, it may prove insufficient to awake the market from its slumber. The data, as we have argued, is unlikely to change the investors or policy makers perception of the economy or of the timing of the tapering.

The only economic data of note has been the UK public finances. Like the US, the UK deficit has fallen more than expected. What was expected to be a deficit of GBP120 bln in the fiscal year is tracking closer to GBP105 bln. Nevertheless, we suspect that like the US, the UK is not going to ease up. Osborne's Autumn Address in early December (that is is called the Autumn Address may be evidence of the famous British humor)is the next big fiscal development.

With money supply growth pitifully weak and lending to the private sector continuing to contract, and euro area experiencing disinflation, it was only a matter of time before some European objections to the euro's appreciation were heard. French officials are likely suspect and the Minister of Industry Montebourg did not disappoint.

In a local interview, he advocated a 10% decline in the euro. He said it would boost French wealth by 1.2%, create 120k French jobs and reduce the deficit by 12 bln euros. Montebourg is an extreme voice within the center-left Hollande government. While he has antagonized French industry previously, his call for a weaker euro is unlikely to ruffle domestic feathers.

Precisely how to achieve this is a different story. Indeed, of the numerous econometric models for currencies, the wishes of politicians tend not to be vary salient. Prior to EMU, Europe was composed of mostly small and open economies (measured by imports plus exports as a percentage of GDP). Post-EMU it is a large but relatively closed economy. 

With recession and high unemployment compressing demand for imports and the decline in unit labor costs and growth differentials helping to boost exports, the euro area enjoys a large and growing current account surplus. At the same time, international fund managers have shifted billions of dollar so portfolio investment and some leveraged funds have been scooping up distressed assets.

Two things can change this dynamic and give Montebourg some satisfaction, though it may not be quite what he has in mind. First, the Asset Quality Review and stress tests could reveal a considerably weaker banking system, while Germany and a few other creditors may be reluctant to fund a new international backstop for them. Second, the anticipated Fed tapering draws nearer, though first we have to get beyond the new spending limits and debt ceiling, interest rate differentials may again move in the US favor.