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The sharp drop in the US unemployment rate last month to 8.6% from 9%, its lowest level since March 2009, was not quite the good news it looks on paper. A large reason for the fall was due to a drop in the overall work force in the US, which means that people are dropping out of the job search. The net loss of people in the work force was nearly 40,000 people. And the labour participation rate duly dropped to 64% from 64.2% in October.
The US labour data was a mixed bag for November. Although the unemployment rate was disappointing (it fell for the wrong reasons) the payrolls figure rose by 120k, higher than the 80k recorded for October. Revisions to the data also meant that a total of 72,000 extra jobs were added in September and October. However, job growth in the US remains lacklustre, and at 120k per month it is only enough to keep the unemployment rate stable.
Hence, risk rallied initially but quickly gave back gains. Once again that 1.3540 level is proving too tough for euro bulls to breach, stocks have followed suit, although European indices have had some stellar gains this morning and US futures are pointing to a higher open later today.
Risk has been given a few reasons to rally: Wednesday's liquidity injection continues to boost optimism across asset markets. Italian bond yields (used as a benchmark to measure stress in the European debt markets) continue to fall today, which is helping other asset markets to rally. The credit rating agency Fitch said earlier that the central bank action eases short-term concerns, which has helped to anchor markets in recent days.
However, if this rally in risk is to be sustained then the long-term issues need to be dealt with, and on that front there was also some news that the market liked. Bloomberg reported that European officials are proposing to channel money from the ECB to the IMF to the tune of EUR200bn. So the IMF would essentially act as a middle man allowing European central banks (including the ECB) to underwrite rescue packages for Spain and Italy. This is one way of getting round the EU's rules that stipulate direct budget financing is banned.
Reports suggest that ECB President Mario Draghi has agreed to this, which is good news since a new plan was needed after the EFSF has had trouble leveraging-up to the EUR 1 trillion that was suggested at the October 26 summit. So it seems like European officials are being realistic: the EFSF isn't working so let us join forces with the IMF to try and sort out this mess. Since the IMF is trained at dealing with debt crises it is wise to use its expertise.
German Chancellor Merkel was also on the wires calling for closer fiscal unity and rejecting any quick fixes to this crisis like hastily constructed Eurobonds. For Merkel it is fiscal unity and then action. She called the crisis a marathon, suggesting that the solution to this crisis could be a long time coming. However, once fiscal unity is implemented then this may well open the door to Eurobonds etc, and this is offering a glimmer of hope to financial markets. Merkel and France's Sarkozy are working on Treaty changes on Monday in preparation for the EU summit on Friday, and all eyes will be on that for the next few days.
However, while the politics might be falling into place, banks are still struggling even after the central bank liquidity bazooka. Essentially Wednesday's action helped to ease dollar funding concerns, but euro concerns remain. Banks are still depositing funds with the ECB rather than lending them to other banks, and Eurozone banks borrowed more than EUR 8bn from the ECB last night, the highest level since March. This suggests that banks are finding it difficult to get hold of euro, which is concerning because of the amount of euro-based assets they hold.
So although sovereign markets have seen stresses moderate in recent days, there are still problems in the inter-bank lending market. Banks have to pay more to borrow from the ECB - hurting their finances even more - yet they have no choice, they need money and right now central banks are the only way to get it. So this crisis is far from solved even after the liquidity boost on Wednesday.
It could be an afternoon of range trading albeit with a bullish bias; next week comes with its own challenges.
Kathleen Brooks| Research Director UK EMEA | FOREX.com
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