US: best house in poor neighbourhood

On Friday, the US once again showed that it is the best house on what seems to be a slowly deteriorating neighbourhood.

Source: Bloomberg

If you were to rate the US payrolls report, you’d probably look to score the overall release a 7.5/10, with the participation rate and wage data really coming in under expectations. The bulls will certainly point to the 20 basis point drop in the underemployment (or U6 rate) rate to 11.8%, while the actual level of job creation seen in August and the revised figure from July was solid.

Europe looking vulnerable

While Europe is sinking into a stagflation hole, money managers are seeing qualities in the US that stand out by a country mile right now. This should help attract some equity inflows, and is also clearly attracting massive one-way traffic for the USD. A weaker EUR may help a number of the ills in Europe, but the weakness will take some time to manifest into inflation.

Certainly, if you look at inflation expectations, you can make an argument that Mario Draghi needs something much more than loose monetary policy to solve what many will say are deeply structural issues. It certainly doesn’t help either when Brent crude is included in the ECB’s inflation basket. This input has been savaged of late.

A full blown governmental bond buying (QE) program is a distant prospect. We’ll need to see Europe in a real pickle before the Germans allow what they effectively see as debt forgiveness. Besides, Mario Draghi feels the central bank has done enough (for now) and probably agrees with German politicians that structural reform at a fiscal level is needed. Given the Outright Monetary Transaction (OMT) was referred and is still being contested in the European court of Justice, it seems logical that the Germans will do exactly the same if the ECB vote on QE.

Asia has been fairly subdued, despite the solid payrolls report, with the Nikkei showing its quality as a hedge against USD strength. The ASX 200 is open, but with most of Australia on holiday, volumes have been 44% below the 10-day average. Most of the attention has been on the sizeable falls in the miners. The Hang Seng is up a touch, but the protest has seemingly entered a critical stage as the holidays come to a close. The protestors will need to keep their numbers high.

US futures have had little in the way of catalysts, with most of the trader’s attention centred on selling NZD’s. News emerged that Sri Lanka had suspended the sale of some Anchor milk powder made by Fonterra.  Gold has also been offered, with the 2013 double bottom of $1180 to $1182 being tested. Certainly a break of this key support looks fairly clear cut. For a rally in gold to materialise, we will need to see EUR/USD rallying, which in itself seems unlikely – it appears to be gravitating to the 200-month moving average at $1.2211.

AUD/USD still way overvalued

AUD/USD has traded in a range of US$0.8692 to US$0.8653 and it will be interesting to see where this pair is at the end of the week. Tomorrow’s RBA meeting will be the key. While there is some scope for positive narrative given the falls in the AUD, this should be tempered by the falls in the terms of trade. In fact, the AUD’s real effective exchange rate (REER) is still way too high, considering the levels of terms of trade. One can also look at other long-term valuation tools, such as the OECD’s purchasing power parity (PPP), which highlights AUD is 23% overvalued relative to the greenback. Thursday’s Aussie jobs report is the usual lottery. However, payback is widely expected, with the economy expected to lose 30,000 jobs (range -100,000 to +30,000).

European markets need to price in the fact that the S&P 500 closed just off its high, so upside should be on the cards. Having said this, price action in Europe is far from certain. As I mentioned, growth is questionable and will continue to be in play as the World Bank and IMF are likely to provide new forecasts this week. Comments from the president of the Ifo Institute for Economic Research suggested that Europe faces a ‘decade or more of chronic stagnation and civil unrest’ in a weekend article.

The short-term focus on the US labour market continues in earnest, with the US jobs openings and Labor Turnover Survey (JOLTS) in focus – and likely to show further improvement. We also get the Federal Reserve’s Labor Market Condition Index (LMCI), which we know gets much attention from the central bank.

This index takes into consideration 19 different labour market statistics, including the participation rate, U6 rate and earnings. On the whole, this has the strongest correlation with the private payrolls report. Watch price action in the US 10-year treasury highlighting that investors are happy to pounce on any sell-offs.

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