Big day today, with the US labour market report – nonfarm payrolls – coming out in the European afternoon. Economists are forecasting 190,000 new jobs created in January with the unemployment rate unchanged at 5%, this would be a decrease in comparison to the December number which was 292,000, but still a fairly healthy number. Recent FOMC minutes and Yellen speeches have shown that the focus of monetary policy decision makers will be on inflation indicators and the strength of the labour market. In recent weeks the markets have moved from pricing in a series of interest rate hikes in 2016 to moving towards a more dovish stance, however I still believe that the market might be getting ahead of itself. In recent memory there has been only one time where the Federal Reserve has actually cut rates while nonfarm payrolls have been showing robust employment growth. As I’ve mentioned in recent blogs it’s one thing to reprice the probabilities of Federal Reserve hikes and thus reassess the correct valuation for the greenback and quite another to start to expect the US currency to weaken significantly. Particularly as other central banks, and not the Federal Reserve are actively pursuing policies that look like they want to weaken their currencies. Look at the ECB and Bank of Japan with negative interest rates, the Peoples Bank of China cutting rates and permitting the official renminbi fix to weaken against the dollar and the Bank of England indicating that there are unlikely to be rate hikes in 2016, and indeed talking about how weak economic conditions are at the moment. The Federal Reserve stands alone in trumpeting the strength of the US economy and taking a pragmatic approach to assessing the effects of global risk sentiment on forward looking domestic economic activity. We might not see substantial dollar appreciation for a while, but there is no reason to believe that the dollar bullish trend is going to change materially from here.
The Bank of England interest decision came and went yesterday, and the most noteworthy outcome was the capitulation of the lone hawk. The voting in recent months has been stable with 8 on hold, and one for a hike. This time around all voters decided to keep interest rates on hold. I don’t think the minutes can be better described than the subsequent Financial Times article, “UK interest rate rise kicked into the long grass”. Governor Carney downgraded its inflation, growth and wage forecasts, clearly nothing is changing on the UK monetary policy front in 2016. Unsurprisingly GBP/USD was impacted by this, with the currency pair retreating from its recent bounce. Interestingly the retracement of the recent correction was almost exactly 50% of the recent impulsive move lower, we continue to believe that new lows are likely.
Across the channel, ECB President Draghi was unashamedly dovish in his speech, I quote “The risks of acting too late outweigh the risks of acting too early”. He was talking about the risk of a destabilising bout of disinflation. From a personal standpoint I really hate this type of talk…“If, on the other hand, we capitulate to inexorable disinflationary forces or invoke long periods of transition for inflation to come down, we will in fact only perpetuate disinflation.” You want to know who hates low inflation? Governments! Particularly governments with lots of debt who are trying to devalue the debt at the cost of their own citizens. You want to know who benefits when inflation is low or non-existent? You and me! And particularly pensioners who depend on fixed incomes, who see their spending power eroded when inflation is higher. I find it extremely frustrating that this narrative from central banks is never challenged by the 4th estate but this is the world that we live in. I’ll stop my rant now…
On another note, President Obama proposed a $10 per barrel tax on oil. Wow! The oil majors must just love him! I’m not sure if he’s trying to lose Texas and the other oil producing states for the winner of the Democratic party nomination or whether the White House calculation is that the green vote is large enough to make the difference. Either way it’s never going to be enacted by a Republican led legislature but it does set a tone for future discussions. For now crude oil looks to have stabilised in the low $30s. From a technical standpoint $36.75 the recent high for Brent becomes a key level. My bias is to look at that level as a ceiling, and I expect new lows in the coming months. There is nothing about global demand and supply conditions that suggests it will be easy to see oil climb above there.
Back to today’s labour market data. This is potentially a huge number that could set the tone for the weeks ahead. If the number surprises to the top side it will show that despite recent market volatility the US economy continues to chug along at a healthy pace. However a data disappointment will give more strength to those who believe the Federal Reserve has made an error in hiking. The market could well move to test the resolve of the US central bank, were that to happen, and the dollar could weaken considerably. We will discuss the outcome on Monday. Have a restful weekend
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