The US dollar weakened on Friday in response to a much softer than expected payrolls result. EURUSD traded up to a high of 1.4825 from a low of 1.4699, while USDJPY traded down to a low of 107.90 from 109.48. Recession fears were evident in the stock market, with the S&P500 down by 2.5%, while US Treasury yields fell by a further 7bp. The money markets are now pricing in 40bp of rate cuts at the Jan 30 FOMC meeting, and just over 140bp of rate cuts over the next 12 months. Non-farm payrolls for December were 18k vs. 115k in November and well below market expectations of 70k. As such, the unemployment rate rose to 5%, from 4.7% in November, and again much worse than consensus of 4.8%. The non-manufacturing ISM Survey dropped to 53.9 from 54.1, a little bit above market expectations of 53.5. On a more positive note, the Fed announced on Friday that it will auction $30bn of 28-day loans via the TAF on Jan 14 and $30bn of 28-day loans on Jan 28, rather than $20bn like in the previous two auctions. The TAF has been quite effective in driving down Libor spreads and reducing counterparty risk in the banking system.
It is a quiet data week in the US, which leaves little scope for markets to revisit prospects for Fed policy after the past week's weaker-than-expected data. In addition to Secretary Paulson's speech later today, there are several Fed speeches on the calendar next week. Fed Chairman Bernanke's speech on Thursday on the US economic outlook will be most closely watched. On the data front, pending home sales, due Tuesday, are expected to be down for November. Weekly jobless claims, out Thursday, are expected to stay elevated. Structurally, the trade deficit, due Friday, is expected to widen. On the political front, the New Hampshire primary looms on Friday, and the focus will be on whether Obama maintains him momentum against fellow Democrat rival Clinton. Our economists have revised their Fed funds rate outlook and now expect the FOMC to cut rates by 50bp at the Jan 30 meeting. As such, even greater than expected cyclical weakness in the US economy raises risks to our near-term EURUSD forecast of 1.45 over 1 month.
Ahead today, the Fed's Lockhart speaks at 1740 GMT on the economic outlook, while Treasury Secretary Paulson speaks at 1900 GMT on "Capital Markets and the Economy".
At 3.1% (cons: 3.1%, last: 3.1%), HICP flash for December released on Friday remained well above the ECB's 2% target. The development was mainly due to higher energy and food prices. Also, the composite PMI for the Eurozone fell to 53.3 in December (cons. 53.3, last: 54.1). The latest figure suggests that activity in Q4 will slow further. Composite input prices fell slightly, while output prices rose to its highest level since the middle of last year. Altogether, this suggests that inflation will remain at elevated levels in the near term. But going further, our economists note that although inflation remains above target, this should not cause the ECB to hike rates at their meeting on Thursday or in the coming months. Instead as growth slows below trend in the Euro zone this year, pressure on inflation to rise will subside until H2/2008. In consequence, the ECB is expected to start cutting rates in the second quarter 2008.
Swiss CPI hit its highest annual rate for 12 years. At 2.0% y/y (cons. 1.9%, last: 2.0%) the figure managed to beat market expectations. The increase was mainly due to heightened prices of imported goods. The release will likely keep the SNB concerned over price stability. At its October meeting, the central bank justified leaving rates unchanged by outlining that the medium-term inflation outlook had improved, while risks to the economy from last year's market turmoil remained unclear. Although inflation is still high, our economists continue to expect no policy steps by the SNB in the foreseeable future. The market's focus will now shift to next week's release of labour data, which continued to show strength in the last few months. Going further, the franc remains highly dependent on risk sentiment, and according to our risk index analysis equity volatility remains one key driver. As such we continue to closely follow equities in order to evaluate the Swiss currency. If risk aversion stays high as it currently is then EURCHF will keep trending lower in the short term. Our three month target for the cross is 1.60.
Australia's largest bank, the National Australia Bank, announced last week that it had increased its variable mortgage rate by 0.12%. This increases the odds that other major banks will follow suit, as they pass on the higher global funding costs on to the borrower. The RBA is unlikely to be surprised by this latest development, but it does reduce the need for the RBA to tighten further. Indeed at the December RBA meeting, the minutes show that they would assess at the February meeting whether the combination of policy action and market conditions would be sufficient to constrain inflationary pressures. The OIS market is now pricing in just 8.5bp of tightening at the February meeting, versus around 12bp prior to this latest development. In New Zealand, the trade balance for November was released this morning and came in with a larger than expected deficit at NZ$656mn. However, this was smallest deficit in 18 months.
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