There has been an obvious build-up of expectations about the U.S. jobs report today. The dramatic jump in the ADP estimate sparked a large upward revision in expectations, even though the shortcomings of its estimate and its track record are well known. In part, the optimism also reflects the recent string of data that has convinced even many of the cynics that the U.S. economy has accelerated. Given the price action and the pendulum of market expectations, the risk today is for disappointment.
The disappointment could lie in the difficulty to live up to some of the inflated expectations, which included talk of a 500,000 rise. With the U.S. economy gaining traction, many observers have simply ignored the fact that the employment component of both the manufacturing and service sector ISM reports weakened. The risk is of a "buy the rumor, sell the fact" type of trading today.
Yet in the larger picture, to be clear, investors ought to see that potential pullback in the dollar as a new buying opportunity and/or opportunity to adjust exposures. The combination of growth differentials, mediated through interest rate differentials and relative returns, and Europe's debt woes will help fuel further dollar appreciation.
By some market-based measures, the European crisis is worse than it was in the May 2010. The immediate focus in Europe is three-fold. First, there are some reports suggesting that a Spanish caja may need to borrow from the government's aid fund (FROB). Private estimates suggest Spanish banks have another €80 bln of bad debt to recognize. On top of the federal and regional government borrowing, and bank borrowing, the FROB is expected to issue around €5 bln of bonds soon.
Second is the sovereign supply next week from Portugal and Italy. The market does not seem to have much appetite for peripheral issuance. Portugal's 10-year bond yield has risen 54 basis points this week. Italian 10-year yields, on the other hand, have slipped 2 bp. The 7 bp that the Spanish 10-year bond has risen this week have been registered today.
Third, there is a cloud of uncertainty over the status of creditors in Europe. German chancellor Angela Merkel was forced to back down from her ill-fated attempt last year to get the private sector to participate in bail-outs (i.e., haircuts) to a compromise position of "only after 2013."
But the proverbial cat is out of the bag. The moral hazard whereby creditors are guaranteed by taxpayers' money is coming to an end. Yesterday the EU proposed that bank regulators be granted powers to write down debt in future crisis. There had been some reports (that we cited earlier this week) that Greece was lobbying banks to extend maturities on Greek obligations in line with the extension that is likely from the IMF and EU. Subsequently the reports have been denied, but many (if not most) observers look for Greek debt to be restructured at some point.
Some investors may be surprised how little the market has really paid attention to press reports playing up Chinese purchases of peripheral European debt. Previously it was the vice-premier, who is tipped to be the next premier in 2012, and today it was the deputy governor of the People's Bank of China (PBOC) who appeared to have made supportive comments.
So what? The market is bigger than China. China is (maybe) a price setter when it comes to iron ore, but not for such bonds as Portugal's or Spain's or Greece's. If Bank A wants to sell its peripheral bond and the PBOC buys it, what difference does it make to that peripheral country or other holders of that same paper?
Altering the holders of the debt also is not the same thing as addressing the unsustainable debt dynamics.
The amount of money being bandied about -- around €10 bln -- is chump change for the PBOC, which saw its reserves jump $200 bln in Q3 10 alone.
The disconnect that it points to, though, is the comments in the recent past about the risks China faced in holding U.S. Treasuries. Are we to believe that those same officials really believe that peripheral European bonds are less risk?
Disclosure: No positions