Following a more detailed look at US jobs data going back 20 years, we note that there has been only 3 occasions when the unemployment rate rose by 0.3%; August 2001, January 2001 and December 1991. Each of those months fell in the midst of a recession. Fridayâ€™s release of the December unemployment rate also showed a 0.3% increase. While the counterargument to such analysis may posit that todayâ€™s unemployment is far lower than the 5% and 7% levels in 1991 and 2001, the response is that todayâ€™s economy is characterized by lower real earnings growth, dragged by rising inflation, and the quality of jobs is a rude reality for those holding more than one part-time job. Finally, falling housing prices, rising interest rate resets and negative equity must be taken into consideration when simply determining the role of jobs in personal incomes and spending.
As we have mentioned in our 2008 outlook, figuring out whether the US economy is in recession may not be as important as determining the overall impact on jobs and personal spending. Thus, GDP growth rate may avoid falling for two consecutive quarters, hence escape the textual definition of recession, but the economy would still be damaged in the event of say two consecutive GDP growth rates of 0.1% or 0.2%, which is far less than the potential growth rate of 3.5%. In fact, the Fed has just downgraded what it deemed to be potential growth to 2.5%.
Finally, we disagree with the notion that aggressive Fed cuts will be successful in avoiding recession because the very conditions that require the Fed to deliver another 75-100 bps of easing are typical of recessions. We should also remind readers that the 50-bp rate cut of last September was an unusually aggressive way to start an easing cycle. All past easing Fed cycles beginning with a 50-bp cut are recessionary.
Our Fridayâ€™s forecast of an improvement in risk appetite and a subsequent increase in yen crosses did not materialize as our assessment was partly founded on the announcement of a new economic stimulus plan by Pres Bush. Yet, there was no plan in the Presidentâ€™s conference, thus, extending the sell-off in equities and the yen crosses. This morning, however, US equity futures are pointing higher and so are yen crosses (yen is lower against other currencies).
Yen gains to stabilize temporarily
We expect risk appetite to stabilize in the absence of market-moving data. Attention this week will revolve around discussions about probabilities of recession as well as speculation ahead of the Presidential Primaries in New Hampshire. While our medium term forecast is for 10-12% decline in the S&P and the Dow, we expect these developments to be attained in a slow consolidative manner as interest from SWFs will smooth out the pace of decline. USDJPY support stands at 109.00, followed by 108.75. Close attention must be paid to the broad equity indices and whether the S&P 500 holds above the 1,400 low. The chart continues to show a classic bearish formation of lower lows and lower highs, suggesting that the possibility of 1,400 loons large, and so are the negative implications for USDJPY and other yen crosses (NZD, JPY and GBPJPY). Considerable resistance stands at the trend line resistance of 109.55, followed by 110.20. `
GBPJPY gained by 3 yen to 216 before retreating towards 215.30s. The pair is hampered by a double whammy of weak UK fundamentals and reduced risk appetite boosting the yen. But as we have seen at the beginning of recessions and phases of protracted slowdown, rising volatility also means period phases of sharp gains. Upside capped at 216.20, followed by 217.00.
Euro to test 1.4620 support
The euro was boosted by a series of hawkish remarks from the ECBâ€™s Trichet, Papademos as well as French Finance Minister. The central bankâ€™s persistently hawkish rhetoric may mean that the outlook for renewed euro gains shall depend more on future inflation, than sentiment/business surveys and consumer demand. We do not expect a break of the 1.4850 as long as looming US recession dislocates risk appetite and elevates global market volatility. We expect the pair to test preliminary support at 1.4670, followed by the 50-day MA of 1.4620. Subsequent target stands at 1.4580.
Sterling capped at $1.9820
While we expect sterling to face further downside towards $1.9550 before by month end, we warn of periodic bouts of profit taking and repositioning, which tends to squeeze out the money shorts. Thursdayâ€™s Bank of England decision is expected to leave rates unchanged at 5.50% as no substantial data are out this week. Yet we continue to expect 100-bps from the BoE this year, as the inflation element begins to fade, permitting the central bank to focus on shoring up the economy and combating the accelerating deterioration in housing. Cable support stands at 1.97 at which point we expect a temporary recovery towards$1.9770 and $1.9820.