The outliers are always the most exciting when it comes to payrolls and that is what we got in this morning’s NFP. The number smashed expectations and came in at 236k, more than 70k higher than expectations of 165k. Even our above consensus estimate at 215k was exceeded. Crucially the unemployment rate also fell to 7.7% from 7.9%, which is only 1.1% away from the Fed’s target unemployment rate of 6.5%. Thus, the closer we get to the target the more likely the debate will shift to the Fed’s exit strategy regarding QE3. For example, will the Fed only think about terminating QE3 once the unemployment rate hits 6.5%, or will they start to withdraw stimulus before that, as the trajectory for unemployment improves? Although one month’s data does not mean a trend has been born, the fact this number is so large is significant and may get the market feverish about the end of QE3.
Market reaction to payrolls:
The initial reaction has been a sharp jump higher in the dollar, particularly against the yen, USDJPY surged above 96.00 – its highest level since mid-2009. The next major resistance level is 97.50 – the double top from August 2009. Treasury yields also jumped above 2%, which has capped gains since April 2012. This is a significant move higher in Treasuries (they often don’t move as much as other markets like equities and FX), and as such should be respected by the market. If this is a new paradigm for the dollar and for Treasury yields it opens up an interesting debate: 1, will the dollar gains be more broad-based from here, for most of this year dollar strength has mostly be concentrated versus the yen and pound (euro weakness was more of a euro move, rather than a dollar strength move). 2, For the “goldilocks” environment in markets to persist then yields can’t move much higher than this.
What it means for EURUSD:
From a market perspective, we tend to think that this payrolls number could be a bit of a watershed for the markets and the FX market in particular. The improvement in US labour markets is in stark contrast to the Eurozone, where unemployment continues to jump to record highs and is expected to get worse this year and peak at 12.2%. The payrolls data had a sharp impact on the spread between German and US yields, which narrowed back to mid-2010 levels – back then EURUSD was approx. 1.25, after falling below 1.20 in June of 2010. Thus, the yield spread supports a weaker euro, and we could see EURUSD drift lower in the coming days and weeks. EUR took a sharp move lower after the payrolls and is below 1.30 as we move into the US session. If we get a weekly close below 1.2980 then we could see a sharper decline back towards 1.25 in the medium-term.
The caveat to this is the ECB. Right now ECB policy (to remain on hold) has little correlation to the German-US yield spread. German yields actually jumped today, suggesting that the key driver of EURUSD in the coming weeks may be the US, rather than what is going on domestically. After the ECB meeting yesterday, it appears that the Bank is in wait and see mode and the economy or sovereign situation will need to deteriorate further to get the ECB to take further action. Thus, the trajectory for this cross will be dependent on the US and the future direction of Fed policy.
What it means for stocks:
Today’s payrolls are also important for stocks. All of a sudden the reasons for the Dow and S&P making record highs this week is being put down to the strength of the economy rather than the Fed’s $85bn of purchases each month. We still think the Fed is a big driver of markets, and could also be the driving force behind the improvement in payrolls. If liquidity is driving markets higher, this could make businesses more confident, which in turn gives them the impetus to hire more workers. Whatever the reason for the surge in jobs last month, this jobs report is strong: 179k of the 236k jobs created were service sector jobs in the private sector, which easily covered the 10k jobs lost in the government sector. One thing to remember is that the sequester kicked in at the start of this month, which could lead to a larger than normal decline in government jobs in March, which have been fairly flat in recent months. Thus, we need to see the private sector keep up the good work if the impact of the sequester and fiscal tightening is to only have a limited economic impact.
US markets opened higher today, and they are poised to round off what has been a historic week for the US equity indices. As we say below, strong economic data in the US could be a double-edged sword for stocks, especially if it causes the Fed to rethink its exit strategy.
To sum up:
• USDJPY is likely to continue to move towards 100.00 in the medium-term.
• Payrolls are EURUSD negative in the long-term; the GER-US 10-year rate spread suggests EURUSD should be closer to 1.25.
• The dollar is likely to outperform EUR, JPY and GBP – where central banks are in easing mode or likely to remain highly accommodative.
• Dollar gains maybe more muted against the commodity currencies like Aussie and Cad (Canada also had a strong employment report today), as their central banks seem to be in neutral mode.
• Overall, this supports the dollar as a growth currency, which is a theme that could develop this year.
• For stocks we are in a goldilocks environment: not too hot to require the Fed to cut short QE, but not too cold either.
• However, this number could mark a watershed for QE3 with the focus shifting to the Fed’s exit strategy – time will tell if there is enough momentum in the US economy to keep stocks breaking fresh ground without the support of the Fed.
One to watch: