John J. Hardy, FX Consultant.
The strong rally in risk into today's close in the US today can't be about this week's economic data - particularly as the ISM non-manufacturing index for August showed a steep deceleration. So why the rally?
The combination of an equity rally and a lousy ISM resulted in the predictable (once those former two variables were known) USD sell-off today. Considering the scary ISM non-manufacturing reading, the market obviously has its eyes fixed on something else besides the data. And we must listen to the market, as it often is trying to look ahead rather than at the present or the past. So what has kept risk appetite elevated all the way through the day today despite an employment report that doesn't even show enough job growth to track the growth in population and despite a services industry survey that suggests employment reductions rather than additions and rapidly slowing service sector growth? The only answer can be the expectations something that will spark at least the hope of short term growth in the economy.
And that hope can only rest on the Obama administration's shoulders rather than on the Fed's, since the Fed is in a bit of holding pattern for at least a couple of months judging from their recent rhetoric. Mr. Obama and his party, however, are experiencing a meltdown in the polls, and don't have the luxury of holding patterns or waiting and seeing. To ensure a better result at the November 2 elections, whey are willing to spend any amount of the nation's capital to kick-start the economy as quickly as possible.
Just yesterday, however, Mr. Obama ruled out any new stimulus package (anything related to spending more government funds would never pass Congress due to united Republican opposition and a new minority of deficit hawk Democrats). And as for the Bush tax cuts, Obama's speech today suggested that an extension of those are unlikely (except for those making less than $200k a year, a stance he has had in the past) since he talked about tax cuts for the "middle class" being in the offing while he talked up the need to pass his new small business bill today. This leaves one big idea out there - the only one that will provide nearly instantaneous stimulus out there to the economy that wouldn't involve new government spending: a payroll tax holiday. It's about the only issue that both parties might agree on since it benefits everyone all the way down to minimum wage earners and puts extra money in consumers' pockets as soon as the next paycheck. Hey, why not even back-date it to June? The only thing holding it back would be the even bigger hole this would leave in public finances and the risk that the bond vigilantes are out there lurking in the shadows (low risk in the short term for that one).
This is our assumption for the "logic" of this tremendous three day rally in risk, at least, as it is certainly difficult to believe that the market invested any real hope in the economic state of affairs after a mediocre employment report and a more important and far more negative ISM non-manufacturing survey. Let's see what Mr. Obama's Labor Day speech brings us (or the speech next Wednesday in Cleveland, which may be "the one"...). After all, we should never underestimate the ability of central bankers and politicians to kick the can of pain down the road in order to get a short term political fix at the expense of long term pain... So if indeed the Obama administration comes up with a tax holiday and it is passed, the question will be how much the faith the market will put in it working magic on the economy. Another few days of rallying or a few months of rallying? This is a potentially big issue as a full payroll tax holiday would certainly put money in consumers' pockets and trigger a spike in end demand, particular for those who habitually spend all of their paychecks every month. If Obama's the new bill aimed at bringing relief to the economy is full of caveats, complex rules and half measures and bears any resemblance to the impenetrable new healthcare and financial regulation efforts, then the upside for risk will be very limited indeed.
If risk markets celebrate Obama's new efforts and the three-rind risk circus remains in full freak-show mode, watch out below on the USD again since it means even more fiscal shortfalls for the US and would mean spillover to the pro-risk emerging markets as well, considering most hard goods purchased in the US are made abroad. On the flipside, if the market is setting itself up for too much and Obama doesn't deliver...uh oh....
Next week will be an interesting one. Stay careful out there.
And now for something completely different
On a side note, an interesting article out earlier today about Japan and the idea that the odds of intervention are lower than the market previously estimated because of US opposition to the idea. Here's the link to the article on Bloomberg.
On a side note, an interesting article out earlier today about Japan and the idea that the odds of intervention are lower than the market previously estimated because of US opposition to the idea. Here's the link to the article on Bloomberg.
Have a great weekend.
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