Were Non Farm Payrolls an early holiday present for dollar bulls? Was it a classic case of the opposition between rumor and fact? Or have the markets given a sign that the economic illogic of the past months is coming to an end? Whatever the reason for the dollar rally, the question is did the payrolls occasion price reversals in three important markets, currencies, gold and Treasuries, or was the entire event just an excellent opportunity for some seasonal profit taking?
In the currencies the dollar index gained 1.7%, the yen depreciated more against the dollar than any single session since 1999 and the euro dropped more than two hundred points. Gold fell hard from its record high of the day before and Treasuries sank farther than any day since the summer. The Dow gave back most of its 150 point gain after reaching a new high for 2009.
Friday's Employment Situation Report from the Bureau of Labor Statistics (BLS) was an unexpected dose of positive news. Payrolls shrank by 11,000 in November, far less than the -125,000 most economists expected. It was the best reading in over two years. The unemployment rate improved dropping 0.2%, to 10.0%, equally unpredicted. The 11,000 reduction in payrolls was small enough so that the BLS officially considered the payrolls unchanged for the month. The American economy may well have produced jobs in November when the revisions are calculated next month.
For many currency traders the reaction to NFP was a simple measure of profit with the added incentive of proximity to year end. But if the US economy is really in rehabilitation stocks will not continue to sell off, gold will and Treasury prices will decline further. If the dollar moves higher commodities will lose some of their trading luster. A higher dollar, lower Treasuries and lower gold are rational and historical reactions to an improving economy.
The anomaly has been dollar itself. Since March the currency markets have been selling the greenback whenever risk falls and rewarding the dollar when risk rises. This has produced the odd and illogical equation of poor US economic results generating a strong dollar and the reverse.
In the context of the financial crash last fall and the almost universal fear of capital loss that reaction was logical; in the current economic conditions it is not. But for a number of reasons this response has been hard for traders to shake free. First, in the back of many traders' minds, if not in reality, lurks the possibility of a reoccurrence of last fall's dollar panic. Second, in the absence of a credible US economic recovery there is no reason to buy the dollar; the Federal budget deficits and very low interest rates are good, if currently disconnected, reasons to sell. And lastly there are the reliable trading profits from the risk aversion trade.
The euro has been unable to break above 1.5140 and one reason is because the EMU economy offers no better potential for expansion than the US. A second reason is the ECB seems no closer to a rate policy change than the Fed.
Normally US economic growth works through to the currency markets through the Federal Reserve. Economic expansion, in time, brings on inflation and a higher Fed Funds rate; the dollar rises.
But since the crash the Fed had deliberately and carefully broken that expansionary-inflation link. Mr. Bernanke fears deflation and the effect of tight money and rising interest rates on incipient economic growth. The Fed Chairman has said so often that rates will stay low for an extended period that the markets have taken it as fact; the Fed will not raise rates. This belief has dulled the normal anticipation that economic recovery and good news would put into the dollar--at least until Friday.
Mr. Bernanke has not changed his tune but traders may have gotten tired of listening. The currency markets have had similar positive dollar reactions to improved US economic news several times in the past six months. But each time traders returned to the risk trade, selling the dollar on good US statistics. The dollar did not gain any long term benefit from encouraging US prospects.
But on Friday it was not only the currency markets that responded normally and logically; so did gold and, most interestingly, so did Treasuries. If bond traders feel free to sell then there is no better long term predictor of a Fed rate increase.
We shall see in the weeks ahead if this positive American news sustains. The recent US ISM numbers, manufacturing and services, were unexpectedly weak. Retail sales and the holiday shopping season do not appear to be generating the kind of strong results that prompt anticipatory business expansion; there is still much to worry about in the real estate market.
Markets are not rubber bands; because the American economy has stopped falling does not mean it will snap into growth. But in this case the dollar may be a leading indicator. If the currency, gold and Treasury markets are no longer waiting for a change in Fed policy, Mr. Bernanke may not have to make up his mind traders will do it for him. But the greater chance is that Friday's moves were an early present-- from traders to themselves.