This column was originally published on RealMoney on April 10 at 7:22 a.m. EDT. It's being republished as a bonus for TheStreet.com readers. For more information about subscribing to RealMoney, please click here.
The most recent U.S.
employment data should help ease anxiety about the resilience of the world's largest economy. The key to the 70% of the U.S. economy driven by the consumer is income, and the key to income is work. The U.S. grew an average of 152,000 jobs per month during the first quarter of 2007 and 164,000 jobs per month on average for the past six months.
This is sufficient to keep the unemployment rate trending slightly lower, and, at 4.4%, it matches its six-year low. Not only are more people working, but the work week has crept up, and hourly earnings are trending higher.
Although the market has yet to embrace my forecast that another
rate hike will be delivered before a rate cut, it has rethought the chances of a cut. Recall that after the late-March FOMC meeting, the market priced in about a 50% chance of a cut at the end of June. Now those odds are about 1 in 10.
Also note that inflation expectations, as reflected by the spread between 10-year Treasury inflation-protected securities and conventional Treasuries, are creeping higher. The break-even now stands at around 250 basis points, the highest level since last August.
The combination of tight labor market conditions and rising inflation expectations provides a compelling case against a near-term Fed ease, especially in lieu of evidence that the housing market problems, and especially the subprime woes, are having a significant impact on the rest of the more than $12 trillion U.S. economy.
Nevertheless, the jobs data are unlikely to alter main themes in the foreign exchange market. Concerns remain about the weakness of the U.S. economy not only in terms of its pace of growth, where a sub-2% GDP reading in the first quarter seems likely, but also relative to the eurozone, where recent indicators still point to the region being in the sweet spot of its cyclical expansion. The European Central Bank is well on track for another rate hike later this quarter.
Watch for clues from ECB President Jean-Claude Trichet after this Thursday's policymaking meeting about whether the move will come in May or June. It's not such an important difference for investors, but speculators definitely will take notice. The fourth quarter of 2006 was the first quarter in nearly five years that the eurozone economy grew faster than the U.S. economy. The first quarter of this year may see this feat repeated.
The first-quarter U.S. corporate earnings season kicks off this week. The roughly three-year streak of double-digit increases in year-over-year results is widely anticipated to have snapped. The consensus is looking for something on the magnitude of 4%.
There is a fear that the loss of earnings momentum rules may limit capital spending. Despite strong demand (both foreign and domestic), record profitability and strong balance sheets, the capex decline has become the new conundrum. Former Fed chief Alan Greenspan suggested, in his widely reported Feb. 26 comments to a business conference, what others have been thinking: that the decline in earnings growth is a sign of the age of the business cycle.
Fed Chairman Ben Bernanke disagrees. He has argued that expansions don't die of old age. Yet the current chairman needs to be careful of dodging one horn of the dilemma only to get stuck on the other. To agree with Greenspan is to abandon the central tendency of the Fed's forecast that the U.S. economy will return to trend growth later this year. To say that business cycles do not die of old age implies that they are
And in that eventuality, the Fed will become the No. 1 suspect in the minds of many for having kept rates too high, too long. The employment report is unlikely to change the outcome of that fundamental debate.
There is another dollar negative looming on the horizon, the International Monetary Fund. There is a G7/IMF meeting at the end of next week. G7 statements tend to paper over differences and talk in platitudes. Circumspect and circuitous comments such as its words of caution about not viewing the yen as a one-way bet seem to reflect a limited grasp of how markets function.
As I have
pointed out, based on data from Japan's Ministry of Finance, foreign investors have been significant buyers of Japanese bonds and stocks in recent months. The diversification of Japanese savings into overseas markets, encouraged by the destruction of a return on savings at home, is clearly a source of supply (and selling pressure) on the yen, but its dynamics may be quite different than the net speculative position in the futures market would suggest.
The IMF, on the other hand, tends to be more pointed. Its World Economic Outlook (parts already released) appears to continue to press its argument that further decline in the dollar is needed to help redress the global imbalances. Its argument appears to have been modified on the margins. It suggests that highly flexible economies, such as the U.S.', are more responsive to changes in real exchange rates.
This seems to run against the impression that the more flexible economy has more shock absorbers to help insulate it or at least allow for a quicker recovery. In fact, this appears to be the IMF's conclusion about the U.S. economy: The slowdown will be short-lived. Also, because the slowdown is emanating from the housing market, the IMF believes that it will have a minimal impact on other countries, unless it spreads outside of housing.
The dollar's recent slippage does not seem to be a function of its large external deficit. Indeed, the stabilization of the U.S. non-oil trade balance has taken place. Rather, in the current context -- with the ECB poised to hike, the economic news stream from the U.S. disappointing (data have generally surprised on the downside) and the Fed not prepared to tighten monetary policy despite the persistence of inflation being above its self-defined comfort zone -- the dollar's downside is seen by many as the path of least resistance.
The other theme, in addition to the weak dollar, is the weak yen. Risk aversion this and risk aversion that -- the bottom line is that the spasm in the financial markets at the end of February-early March was short lived. The near-panic unwinding of short yen speculative positions dovetailed nicely with the seasonal repatriation of capital back into Japan.
Equity markets have generally recovered, with some markets, including China, South Korea, Singapore and Mexico, rising to new record highs. The Emerging Markets Bond Index Plus, or EMBI+, spread over U.S. Treasuries has fallen to a new record low of about 161 bp (having peaked near 193 in late February).
The Commitment of Traders data confirm that speculators in the futures market are once again building short Swiss franc and short yen positions. The speculators in those markets have not been net long yen or Swiss francs since last June.
Marc Chandler has been covering the global capital markets in one fashion or another for nearly 20 years, working at economic consulting firms and global investment banks. Currently, he is the chief foreign exchange strategist at Brown Brothers Harriman. Recently, Chandler was the chief currency strategist for HSBC Bank USA. He is a prolific writer and speaker and appears regularly on CNBC. In addition to being quoted in the financial press, Chandler is often a guest writer for the Financial Times. He also teaches at New York University, where he is an associate professor in the School of Continuing and Professional Studies. While Chandler cannot provide investment advice or recommendations, he appreciates your feedback;
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