Notes From Underground: The Uncertainty of Unemployment in an Uncertain Market

Before we get to the analysis of tomorrow’s unemployment release, we will note two tales of interest moves by different central banks. The Danes lowered rates by 5 basis points as the Danish Krone has strengthened enough against the euro to warrant a tweaking of the rate. The official Bank of Denmark rate is 1.15%, so the move is meaningless but does show how the euro is being affected by the strains in the European periphery.

The other move was the Chinese monetary raised the bank rate 3 basis points and somehow the markets reacted as though this was significant. We are quite amused by this for the Chinese are more apt to raise reserve requirements when they desire to send a message to the markets. The initial reaction was a selloff in equity and commodity markets, and as traders we will not argue the point because we respect market action no matter how irrational.

The YEN was sold off hard as the new finance minister made a statement about his desire for the YEN to weaken. We reported three weeks ago that Naoto Kan was worried about a strengthening YEN in a deflationary environment. Mr.Naoto was taken very seriously with his latest statement as he is now the primary policy director. The YEN weakened across the board as all the YEN crosses were sold off. We still await a sharp equity selloff to test the resolve of the YEN to emerge as the funding currency for the global carry trade. Market participants are more apt to sell a currency that a government desires to weaken–the game is now on, but we need to see a test of this when markets are under duress.

In a surprise announcement this afternoon, the FED released an advisory reminding depository institutions to get their interest risks in order and to invoke sound practices of risk controls. Bank holding institutions were also warned to do the same. The market has taken this to mean that the FED is getting serious about raising rates and a return to some sense of normalcy in credit for they know the banks are complacent about a very low rate environment. We disagree with the consensus view and see this more as a move to cover their ass on the regulatory front. The FED has been under pressure for dropping the ball during the early part of the decade and now they want to be sure that they are taking the lead in advising banks on interest rate and credit risk in a realtime manner. It does make one wonder though about the timing of this advisory. The initial impact was felt more in the commodity markets than elsewhere, which seems to be the correct response. Equity markets should be able to absorb several interest rate hikes if the economy is strong enough for the FED to begin raising as we are at very low historical levels.

In regards to the unemployment report, the optimism is growing that this number will surprise to the upside. The consensus is for a zero nonfarm payroll (NFP) and for the rate to be unchanged at 10%. Average hourly earnings are expected to rise 2 cents and the average hours worked to hold steady, although look for increased hours in manufacturing. We think a 100,000 gain will be deemed positive and any initial selloff in the equities should be bought as the FED will be slow to respond as they want to see a trend and not a one-off event.

The bigger question is what this will do to the curve? We think a 100,000-plus number would lead to a bear flattener for the day as the short end would be hit harder than the long end as the Christmas season saw a sharp selloff of treasuries. Watch the 2/10 treasury curve for any technical weakness to lend support to the bear flattener argument. Strength in the employment numbers would prompt a rally in the DOLLAR that is looking for a reason to shake the currency markets out of their present ranges. The GOLD will sell off too, but we would like to see it test support and then see if GOLD will rally against all the fiat currencies as one “strong” set of data will not be enough to move the 1937 mentality that dominated the Federal Reserve Board. As long as there is a large negative output gap, this FED is going to err on the side of caution for an “extended period.” Patience and preperation will be rewarded.

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