US Labor Data Confirms Another Round of Quantitative Easing
The labor data here in the US provided the equity markets with a pleasant outcome Friday as stocks ended the week on a positive note. The dollar didn’t have such a good week, dropping just over one and one half percent versus the major currencies. This week will be dominated by the FOMC meeting here in the US and the German constitutional court ruling on the other side of the pond.
But we will start with a recap of events on Friday. The US labor department reported the biggest decline in factory jobs in two years, contributing to a disappointing increase in payrolls during August. The US economy added just 96,000 jobs last month after a revised 141,000 increase in July. The median estimate of economists surveyed by Bloomberg called for a gain of 130,000 jobs. Factory payrolls declined by 15,000 workers last month and was the major contributor to the drop in jobs. Details of the report showed the workweek shrank, and the number of industries hiring new workers plunged to the lowest level in almost three years. Definitely not a good sign for the prospects of the unemployed factory workers, and exactly what the current administration didn’t want to see. A lot was made of the rebound in the auto industry, but the data showing that manufacturing jobs have decreased throws cold water on that line of thought.
But the president and his supporters can still point to the unemployment rate which dropped to 8.1%. Yes, the number of people working dropped, at the same time the unemployment rate also dropped. Much like last month, the unemployment rate and monthly jobs data seemed to be in conflict. But unlike last month when the difference was blamed on inconsistencies in the generation of the reports, this month’s conflict could be more easily explained. Americans are leaving the workforce at a faster pace than they are entering it. 368,000 Americans left the labor force last month, most of them giving up looking for new work. The participation rate, which shows the share of working-age people in the labor force, fell to 63.5% from 63.7%. There are currently fewer working-age people in the labor force than at any time since September 1981. That one piece of data is a great indicator of just how bad things are here in the US.
The labor data have increased the odds of action by Bernanke this week. The Federal Open Markets Committee will be meeting on Wednesday and Thursday, and the Chairman is expected to announce another round of stimulus for the markets during his press conference Thursday morning. During my presentations out in San Francisco, I shared my thoughts that there was just slightly higher than a 50% chance of another stimulus announcement this month. I felt it was just too close to the presidential election for the Fed to act; as they try to avoid the appearance of being too political. But Chairman Bernanke has pointed toward the stagnant labor market as the key to further stimulus, and Friday’s report should provide him plenty of cover to avoid looking too political. The markets are certainly expecting Bernanke to announce another round of stimulus; I saw a survey this morning which put the odds of another stimulus announcement this week at 99%!!
The question now is exactly what will Bernanke announce. Some now believe he will model his new program off of the ECB’s, announcing unlimited additional bond buying. This would allow the Fed to continue purchasing bonds until they feel the economy shows more definite signs of recovery. The advantage of this program, as shown by the reaction to the ECB’s announcement last week, is that the markets can’t question the ability of the central bank to take action. But unlike the ECB program which is solely aimed at sovereign debt within 3 years, the Fed’s new program will likely be aimed at mortgage debt with longer maturities. Another difference is that the ECB won’t buy bonds unless a country asks for a rescue, and then the bond purchases will come with austerity commitments by the country seeking help. The Fed’s quantitative easing program won’t have any austerity measure tied to it; in fact it is more of an ‘anti austerity’ program adding to our deficits and debt in the interest of stimulating growth.
Friday’s labor report and the resulting increase in expectations for another round of stimulus led to a rally in gold and treasuries and a continued fall in the value of the US dollar. Investors, worried about the inflationary impact of additional stimulus measures, took gold to the lofty levels it was trading at back in March. While prices moved down a bit going into the weekend, gold is still firmly entrenched in an upward trend and certainly looks like it will challenge it’s former highs.
The dollar lost ground versus most of the major currencies on Friday, ending a week in which the dollar index fell over 1.5%. I guess the ‘Chuck is off the desk rally’ held true again. In years past, whenever Chuck has been off the desk for an extended period, we always seem to have a currency rally, and last week’s dollar action was a confirmation of this pattern. As I explained last week, the reason for the fall in the US dollar is a fairly simple case of supply and demand. The Fed will be creating a whole lot of dollars which it will be using for the bond purchases, and this increase in supply will eventually lead to inflation. It may not be reflected immediately in the price of goods and services, as international investors still seem to have an appetite for the freshly minted currency. But eventually the demand will slacken, and at that point we could see a spike in inflation. Bernanke has told us he is aware of this risk, but he is convinced the Fed can pull the newly created dollars back out of the markets as fast as he is adding them. I guess we will just have to wait and see if he is correct, but the markets are starting to hedge their bets.
The ECB action last week helped the euro (EUR) push above the $1.28 handle, but it gave it back and is hovering just below it this morning. Concerns over the German Constitutional ruling due out this week, combined with renewed concerns in Greece put a lid on the appreciation of the single currency. The German court is expected to give its ruling on Germany’s participation in the European Stability Mechanism on Wednesday. The court is expected to allow for Germany’s participation, but currency traders are worried they may put stipulations on any future participation of Germany in European bailouts. Both German Chancellor Angel Merkel and Finance Minister Wolfgang Schaeuble are confident the German court will allow the establishment of the ESM, allowing the bailouts to continue.
Greek Prime Minister Antonis Samaras is due to meet officials from the ECB, IMF, and EU today. Samaras failed to secure an agreement to the 11.5 billion spending cuts required for the release of the next round of rescue funding. After this year’s two elections, Samaras is operating with a minority government and must get his two coalition partners to agree to the austerity measures. At least one of the two is demanding the cuts be combined with growth measures. “The recession is deep and if these measures aren’t accompanied by growth measures, they will be ineffective,” according to Greece’s Democratic Left leader Fotis Kouvelis. “Our European partners need to know that Greeks can’t take anymore. Nothing can be taken for granted.” Sounds like we could be in for some more volatility in Greece. We warned you that the rollercoaster ride of the euro isn’t over yet, so just make sure you are strapped in!
The Canadian dollar (CAD) rallied to a yearly high this morning after a report showed employment in our northern neighbor rose faster than forecast. Canadian employment rose by 34,300 jobs in August, offsetting a decrease of 30,400 the month before. The unemployment rate remained at 7.3%, right on target with median forecasts. While the number was definitely a positive sign, the Canadian economy is expected to remain in a slow growth mode. Last week the Bank of Canada left the key interest rate unchanged at 1% in an effort to encourage investment and consumption to drive growth.
Carney has reflected a hawkish tone, as increases in the prices of commodities which make up the majority of Canada’s exports threaten to push up Canadian inflation rates. The increase in commodity prices caused the BOC to reiterate that interest rates may have to be raised in order to prevent inflation from accelerating. Following last week’s BOC meeting, Carney said “some modest withdrawal of the present considerable monetary policy stimulus may become appropriate.” Higher interest rates would give even more support to the Canadian dollar, sending it to new yearly highs.
The Australian dollar (AUD) moved lower in early European trading after a report showed China’s imports slowed. Both Canada and Australia have commodity driven economies, and the commodity markets are dependent on strong demand from China. A report released earlier today showed China’s imports slid 2.6% in August from a year earlier, the first decline since January. The same report showed Chinese exports rose 2.7% and a different report showed production increased 8.9%. The Chinese President sounded a warning, saying China’s economic expansion faces ‘notable downward pressure’.
The pace of the global economic recovery is going to be dependent on Asia, as both the US and Europe’s economies continue to struggle. So the news that Chinese imports slowed are worrying. China has been slowly changing from an export driven economy into one driven more by internal consumption, so the slowdown in imports is concerning. And concerns regarding the Asian growth prospects were heightened further with the release of Japanese GDP measures which showed the economy grew at just .7% during the 2nd quarter, less than the preliminary reports which predicted a 1.4% increase. The median forecast of economists was right in the middle of the two figures at 1%. The spending which was necessitated by last year’s earthquake and tsunami helped push GDP up slightly, but that spending is now over and gridlock in the Japanese parliament is preventing any additional stimulus. There is a good chance the Japanese economy could slip back into contraction in the 3rd quarter. I continue to warn against investments in the Japanese yen, and actually look at it as one of the currencies which could fall the most as investors start to move back into higher yielding currencies.
To recap. Friday’s monthly jobs reports showed a US economy which is still struggling to recover, and put the possibility of a stimulus announcement by the Fed at almost 100%. The future of the ESM (and therefore the euro) rests in the hands of a German Constitutional court which is expected to rule later this week. But the court is widely expected to rule in the euro’s favor, and the single currency continued to rally. The possibility of another round of stimulus had gold rallying along with the commodity currencies. The loonie hit a yearly high but the Australian dollar moved lower after a Chinese report showed imports decreasing. Japan’s GDP came in at ½ of what was originally predicted, and further stimulus isn’t in the cards for the Japanese yen.