US non-farm payrolls grew by 56,000 in October from a revised decline of 8,000 in September August, while the unemployment rate fell to 5.0% from 5.1% and average hourly earnings jumped to 0.5% from 0.1%. The revisions for August and September were a 63,000 decrease and a 27,000 increase respectively, netting an upward revision of 36,000.

The impact of Hurricanes Rita and Katrina remained notable throughout the report as it led to a surge in construction jobs and declines in education and leisure/specialty. Construction employment grew by 33,000, well above the 21,000 monthly average of the year prior to October due to demand for construction and clean up jobs. The manufacturing sector finally showed a creation of jobs after 4 consecutive monthly declines largely thanks to the return of 18,000 striking workers from the aerospace industry.

Continued declines in the leisure and hospitality industries also stemmed from the hurricane afflicted tourism industries in the South East. Leisure & hospitality jobs fell by 18,000 in October following a 63,000 drop in September. Those were the first back-to-back monthly declines in the industry since Feb-Apr 03, when sentiment was shaken by the invasion of Iraq.



On the inflation side, the 8 cent increase in October average hourly earnings to $16.27 marked a 0.5% monthly increase, the highest since February 2003 when oil prices soared amid mounting uncertainty ahead of the Gulf War II. The figure may get the attention of the markets as far as inflation is concerned as it suggests wages are catching up with higher energy prices. But the employment cost index continues to stabilize at its 0.8%-0.9% trend rate following the 1.1% high seen in Q1 of 2004.



The two latest jobs reports are pushing markets further in uncertainty raising questions as to whether the slowdown is largely attributed to the Hurricanes or are part of a cyclical slowdown in the overall economy.

Dollar Focus

The post-labor report FX market reaction comprised of a brief dollar retreat followed by a sharp 2-cent rally against the euro, pushing the single currency down to 18-month lows at $1.18. The dollar also broke out key resistance against the yen, hitting a 27-month high at 118.32. Two factors to which the dollar rally has been attributed are the 27K upward revision in the September report and the Homeland repatriation flows.

Indeed, traders and analysts have grown to attribute several of the recent dollar rallies to ongoing USD-bound flows resulting from the Homeland Investment Act--part of the American Jobs Creation Act passed last year aimed at reducing the corporate tax on foreign subsidiary income from up to 35% to 5.25%. Repatriation amounts have been estimated to range $200-$400 bln, about a third of which would involve currency conversion into dollars. The Washington-based American Shareholders Association said Bureau of National Affairs told Market news International last month that $214 billion in repatriated profits had been announced by S&P; 500 companies by mid-September, up from the $191 billion estimate made in mid-August by the International Strategy and Investment (ISI) Group. Since the tax breaks are due to expire in Dec 30 of this year, further repatriation could be expected in the coming months by companies seeking to take advantage of the tax savings. The ASABN said it expects about $70 billion of additional flows before year-end.

The HIA has also triggered considerable buying on the dips (euro-to-dollar conversions) by corporate treasuries of US multinationals seeking to reap the benefits of the Act in light of the euro’s several highs (early Sep, early Oct and late Nov). These flows have provoked sharp dollar up moves but constantly tapered off around the $1.19 resistance in the greenback. But the break below the $1.1866 year low to $1.18 could signal a serious deterioration of sentiment, especially if the notion of post January Fed tightening starts to take hold in Wall St.

The ensuing 8-day violence in France following the deaths of 2 young immigrants is fuelling political uncertainty in the Eurozone’s second largest economy. Interior Minister Nicolas Sarkozy has come under fire for his poor handling of the riots and or fuelling the fire, which could jeopardize his aspirations in the next presidential elections. Meanwhile, President Chirac’s dubious state of health coupled with his failure in stabilizing unemployment and quelling Union unrest is beginning to burden him with “lame duck” status.

Finally, the expectations of a December rate hike by the ECB should be the only euro-specific positive that could help offer some support. Next week’s US trade data could well be overshadowed by renewed dollar momentum even in the event of a figure above $61-62 billion. The 38% retracement of the 85.63-1.3664 rally at $1.17 can be attained as early as next week.

In a widely anticipated decision, the ECB chose to keep interest rate levels intact at 2% this morning. The announcement, followed by stronger than expected Q3 Non-farm productivity figures and October Services ISM index, resulted in renewed strength in the dollar against the euro, as the pair broke below the $1.20 threshold to a daily low of 1.1934. Effects of economic data was accentuated by accompanying remarks from both central bank chiefs, as ECB president Jean-Claude Trichet expressed concerns about inflationary pressure of rising energy prices on European economy while Fed Chairman Greenspan remained upbeat on the outlook for the US.

In the latest installment of resiliency in the US economy, productivity of the U.S. non-farm business sector surged at a 4.1% annual rate in the third quarter. Economists were expecting a more mild increase of 2.6%. Productivity in the second quarter was upwardly revised to a 2.1% increase from the 1.8% estimated two months ago.

Unit labor costs registered a 0.5% decline in Q3 - the biggest quarterly decline since Q2 of 2004 – beating the consensus estimate figure of 2.0% by a wide margin.

Activity in the U.S. services sector has also shown improvement in October, with the ISM non-manufacturing index rising to 60% from last month’s 53.3 figure and higher than the anticipated reading of 56.9%. Figures over 50% are indicative of the plurality of firms reporting increased manufacturing activity.

The jobs outlook is also painting a rosier picture, with initial jobless claims falling 8K to 323K, levels unseen since prior to Hurricane Katrina ravaging the US Gulf Coast. The 4-week average dropped 17K to 350,500 – the lowest figure since September 10th. Analyst expectations called for 332K while last week’s numbers were revised slightly higher to 331K.

Currency markets are looking forward to tomorrow’s October change in payrolls report for further indication of the recovery from damage done by Katrina to the US employment picture. Estimates range from 90 to 100 thousand after last month’s reading of –35k.

Trichet Signals Vigilance to Inflation, Declares Current Rates “Appropriate”

In ECB’s closely scrutinized press conference accompanying the interest rate decision, President Trichet expressed concern over near-term inflation, citing rising oil prices as well as credit growth. However, he also appeared impressed with Euro Zone resiliency to oil shock and pointed to a lack of build-up in core inflationary pressures.

Traders interpreted his remarks as cautious but hardly indicative of the hawkishness expected in the likely event of rates remaining unchanged. With ECB’s press conference commentary clouding the likelihood of a rate hike at the next scheduled meeting, the markets punished the euro against the greenback and the yen.

Euro Surrenders Two-Day Gains

The euro was unable to preserve the gains it made against the greenback in two consecutive sessions, falling as low as 1.1934 – a level unseen since October 24 rally began. Euro bulls were clearly disappointed by the neutral stance of the ECB remarks, sending the single currency toward the lower end of the month-long trading range spectrum. New resistance is found at 1.2020 followed by 1.21, while support rests at 1.19 followed by 18-month lows near 1.1860.

USDJPY Reaching for New Heights

The yen continued to be victimized by strong economic data out of the US and hawkish Fed rhetoric, falling to fresh 26-month lows of 117.37. Following today’s market holiday, tomorrow marks the release of September Overall Household Spending, with consensus estimates calling for a smaller monthly decline of 0.2% following the August 0.5% drop. Further resistance is found at 118.00, followed by the 50% retracement of the 135.11—101.66 decline at 118.45. Support stands at 116.65 backed by 115.70-75 levels.

3:55 am Ger Oct Services PMI (exp 56.5, prev 56.2) 4:00 am E-12 Oct Services PMI (exp 55.0, prev 54.7%) 4:30 pm UK Oct Services CIPS (exp 55.0, prev 55.0) 7:45 am ECB rate announcement (exp 2.00%, prev 2.25%) 8:30 US Q3 Productivity (exp 2.4%, prev 1.8%) US Q3 Unit Labor Costs (exp 2.0%, prev 2.5%) Weekly Jobless Claims (exp 332K, prev 328K) 9:45 am Treas Secrtry Snow Speaks 10:00 am US Oct Services ISM (exp 57.0, 53.3) 10:00 am US Sep Factory Orders (exp 0.0%, 2.5%) 10:00 am Fed Chairman Greenspan testifies to Congress.

Currency markets turn to a fresh comparison between the Eurozone, UK, and US on the services sectors for the latest gauge of the largest sectors in these economies. But the European Central Bank’s decision at 7:45 am NYT (12:45 pm GMT) should set the initial tone of the market as traders expect interest rates to be held steady but still allow for a minor possibility for a surprise rate hike. More importantly will be the press conference held by ECB’s JC Trichet who will give the Bank’s latest rationale for its decision and its current assessment on the risk of whether inflation’s second hand effects will begin to threaten the Bank’s price stability mandate.

Fed Chairman Greenspan’s testimony to Congress isn’t expected to shed fresh light on monetary policy as the FOMC has just raised interest rates with a statement that echoed its insistence to combat inflation.

This morning’s services data from the Eurozone is expected to hit a fresh 14-month high in October at 55 from September’s 54.7, while Germany’s PMI is seen up 0.3 pts to 56.5. The UK’s services CIPS is seen holding in the 55 figure which will foretell the strength of private demand in the domestic economy. Finally, the US ISM, is expected to recover from its 2 ½ year low of 53.3 to 57, which would be important as it would rebound above the UK and
Eurozone counterparts.



Euro turns to ECB press conference

Once traders see no rate hike from the ECB this morning, the next stop would be the JC Trichet’s press conference press, where the bank president will be mulled regarding his hawkishness towards second round effects, house price inflation and monetary liquidity. Language that employs words such as “inflation vigilance” will be scrutinized. Even though the preliminary October CPI slowed to 2.4% y/y from September’s 2.4%, the Bank will need to lift rates from their 40 year lows in Devember.

Expectations of a Dec rate hike should keep the euro underpinned around the $1.2045-50s, after which comes the $1.2080 target. Support starts at $1.2020, followed by $1.1970.

USDJPY relentless despite holiday trade

The high yield differential story underpinning the USDJPY remains the prime story despite a market holiday in Japan today as institutioal players still find it costly to hedge their foreign outflows, which only reinforces the dollar rally to fresh 27-month highs at 116.96. As long as the central bank states that an end to its quantitative easing policy does not imply an end of zero interest rate policy, the Japanese currency should remain pressure.

Resistance remains underpinned at 117.20 with further upside capped at 118.00, followed by the major 118.45 target, which is the 50% retracement of the 135.11—101.66 decline. Support starts at 115.70-75, backed by 115.20.

Aussie adrift after poor sales data

The larger than expected 0.3% drop in September retail sales following a 0.6% decline seems to further quash prospects of an RBA rate hike, which in light of the Fed;s tightening, is exacerbating the Aussie’s misfortune. The 74-cent marks the 100-wk average, below which comes in the key 73.64 cent foundation—the 38% retracement of the 63.39-80.02 rise. Upside capped at 74.90, followed by 75.30.

Euro gained nearly a full cent against the dollar at $1.2084, while hitting a 22 month high against the yen at 141.04 amid escalating expectations of an ECB rate hike this year. The fact that euro rallied past the $1.2050s one day after the Fed’s unanimous rate hike and insistence to deliver more tightening means that markets are discounting a 25-bp ECB move in December to stem inflationary pressures. Although US bond yields soared to a frsh 8-month high of 4.61%, the euro as well as the pound and swissie kept the greenback on its back.

Even if the ECB does not tighten tomorrow (40% chance of a tightening), the euro would remain underpinned on fortified anti-inflation rhetoric in tomorrow’s post-announcement press conference, paving the way for a December hike. Although a 25-bp ECB tightening would keep the Fed-ECB differential at 2.25% (after a Dec Fed hike), we expect it to signal the beginning of the end of the Fed’s campaign.

The most fundamental difference today from the last Fed move in September is persistently high inflation readings in the Eurozone above the European Central Bank’s 2.0% preferred ceiling are showing no signs of retreat. Numerous ECB officials have warned that 2006 inflation could surpass the 2.0% for longer than expected. Considering that Eurozone's manufacturing PMI gained reached a 13 month high in October at 52.7--which was also the 5th consecutive monthly gain in the index--markets may deem an ECB tightening to be more tolerable. The Eurozone's PMI echoes the 5-year high in Germany's IFO climate Index--which hit 98.7 in Oct—as well as the rise in Germany's Oct ZEW Indicator of Economic Sentiment.



The chart above shows the highly positive relationship between the ECB’s refi rate and the IFO climate index since the inception of the euro in 1999. The relationship is especially cogent between 1999 and summer 2003, until after which the ECB had to maintain rates at their 40-year lows as part of the global reflationary campaign, whereby a government uses fiscal or monetary stimulus in order to expand a country's output, by the world's major central banks to combat disinflation. Stagnant euro zone growth has prevented the ECB from joining the Bank of England (BoE) and the Fed’s tightening . But signs of a recovery (IFO, ZEW, today's larger than expected 36K drop in German Oct unemployment) and inflationary pressures make an ECB tightening a high probability in Q4, thus providing key euro support at the $1.19, with a target between $1.2150-1.22 at end of November

3:55 am Ger Oct Change in Unemployment (exp -19K, prev 39K) 3:55 am Ger Oct Unemployment rate (exp 11.6%, prev 11.7%) 7:30 pm Australian Sep retail sales (exp -0.1%, prev 0.6%) 7:30 pm Australian Sep Trade Balance (exp AUD -1.5bln, prev AUD -1.6 bln)

The dollar is mixed in afternoon Asian trade about 12 hrs after the Fed’s widely expected decision to raise the fed funds rate by 25 bps while maintaining vigilance on short-term inflationary pressures and signaling its insistence to tighten for at least 2 more times. But the dollar is a little higher against the yen, Aussie and loony.

Despite the accumulated yield potential favoring the dollar, markets were hesitant in rewarding the dollar as the fed funds rate is now closer to its peak than it was nearly 2 months ago, which reduces traders’ appetite to rush into high-yielding currencies. Another fundamental issue is the emerging hawkishness from the ECB coupled with the recent data showing improved business sentiment as well as mounting inflation in Euroland.

We have noted in yesterday’s note the highly positive relationship between the ECB’s refi rate and the IFO climate index since the inception of the euro in 1999. The relationship is especially cogent between 1999 and summer 2003, until after which the ECB eased interest rates to 40 year lows as part of the global reflationary campaign by the major central banks to fight disinflation. Stagnant Eurozone growth has prevented the ECB from joining the BoE and the Fed’s tightening. But signs of a recovery and inflationary pressures make an ECB tightening a high probability in Q4.

Euro stabilizes as focus shifts to ECB

The single currency has managed to push further above the $1.20 level despite the Fed’s unanimous decision to deliver its 12th rate hike and to signal further tightening ahead. But the fact that euro moved towards the $1.2020s means that markets already beginning to discount a 25-bp ECB rate hike in December to stem inflationary pressures. But we think that even if the ECB does not tighten tomorrow (40% chance of a tightening) the euro would remain underpinned on what we think could be more hawkishness from the ECB press conference paving the way for a Dec hike. Although a 25-bp ECB hike would keep the Fed-ECB differential at 2.25% (after a Dec Fed hike), we expect it to signal the beginning of the end of the Fed’s campaign.

Upside remains at $1.2045-50—38% retracement of the $1.2172-$1.1966 decline, followed by $1.2080. Support starts at $1.1945, followed by $1.1910.

USDJPY remains dollar’s primary booster

USDJPY hovers at a fresh 25-month high of 116.85 shrugging the greenback’s retreat against European FX as the Bank reiterated it would keep rates very low despite its upward revision for inflation. Speculation that the BoJ is encouraging yen weakness to force inflation into becoming positive is circulating in FX markets. But as long as the central bank states that an end to its quantitative easing policy does not imply an end of zero interest rate policy, the Japanese currency should remain pressure.

Today’s breach of 116.65 paves the away for 117.20. Key resistance stands at the 118.00 figure, followed by the major 118.45 target, which is the 50% retracement of the 135.11—101.66 decline. Support starts at 115.70-75, backed by 115.20.

Aussie drifts at 4-month lows

The widely expected decision by the Reserve Bank of Australia to leave rates unchanged at 5.50%, coupled with the Fed’s decision to tighten added to Aussie selling past the 74.30 cent support, opening the way to 4-month low territory. This evening’s trade data should be taken in stride if it falls within a deficit of AUD 1.5-1.7 billion, but an expected 0.1% drop in Sep sales could further pressure the Aussie towards the 74 cent figure.

74-cent marks the 100-wk average, below which comes in the key 73.64 cent foundation—the 38% retracement of the 63.39-80.02 rise. Upside capped at 74.90, followed by 75.30.

In its 12th interest rate hike of the present tightening cycle, the Federal Open Market Committee stuck to the script of the September decision with 25-bp rate hike to 4.00%, maintaining vigilance over potential inflationary pressures of rising energy prices and preserving its quest to remove policy accommodation “at a pace that is likely to be measured”.

Of equal importance is the unanimity of the decision. Fed Board governor Marc Olson voted with the rest of the 9 members to raise rates after he was the lone dissenter at the September meeting because he preferred seeing “additional information on the economic effects resulting from the severe shock of Hurricane Katrina”.

Mr. Olson’s consent to the tightening means that the Committee firmly believes in the positive economic effects of the rebuilding spending from the hurricane-affected areas. This bolsters the case of the Fed’s anti-inflation pursuit and helps rid of any misconceptions regarding the conviction of the FOMC’s resilience.

Going forward however, the question to ask is whether aggregate demand will be broad-based. As we have seen in Friday’s release of the advanced Q3 GDP report, growth was largely thanks to a most from personal and government expenditure--the latter resulted largely from a 10.2% rise in national defense spending.

But business investments’ contribution to GDP was the lowest positive (above zero) contribution to GDP growth since Q2 2002. On the external side, net exports’ contribution fell to 0.08% -- the lowest positive contribution since Q1 2003. The negative contribution from private inventory investment of 0.55% was the lowest in dollar terms since Q4 2001, when companies’ reduced inventories were not replenished following the attacks of Sep 11.



What’s different in FX now from Sep 20?

One evident difference from the September 20 rate hike is that the dollar is closer to peak fed funds rate than it was nearly 2 months ago, which reduces traders’ appetite to rush into high-yielding currencies. Unlike the Aussie, however, the greenback has at least 50 bps in store to sustain it to fresh highs due to the inflation realities.

But there’s a more fundamental difference at hand. Persistently inflation readings above the European Central Bank’s 2.0% preferred ceiling are showing no signs of retreat. Numerous ECB officials have warned that 2006 inflation could surpass the 2.0% for longer than expected.

Considering that Eurozone's manufacturing PMI gained reached a 13 month high in October at 52.7--which was also the 5th consecutive monthly gain in the index--markets may deem an ECB tightening to be more tolerable. The Eurozone's PMI echoes the 5-year high in Germany's IFO climate Index--which hit 98.7 in Oct—as well as the rise in Germany's Oct ZEW Indicator of Economic Sentiment.

While the Eurozone is closing the margin with the US on the manufacturing side, the Eurozone’s services sector has already overtaken its US counterpart in September for the first time in over 2 years. These broadening improvements in the region accompanied by rising price pressures place the possibility of a Thursday rate hike by the ECB at 40-45%. But expect the euro to remain well supported in the event of a no-hike tomorrow as they deem the prospect of a December tightening quasi inevitable.

The chart below shows the highly positive relationship between the ECB’s refi rate and the IFO climate index since the inception of the euro in 1999. The relationship is explicitly clear between 1999 and summer 2003, until after which the ECB had to maintain rates at their 40 year lows accompanying the Fed’s anti-disinflation crusade. Stagnant Eurozone growth has prevented the ECB from joining the BoE and the Fed’s tightening. But signs of a recovery and inflationary pressures make an ECB tightening a high probability in Q4, thus providing key euro support at the $1.18, with a target between $1.21-1.22 at end of November.