Payrolls The Focus, Risk Of Weekend Squaring

O/N BULLETS

• ECB's Knot says euro may collapse if Greece forced out.
• Japan's Azumi says watching FX closely – says EUR decline having a big export impact

USD

The USD continues to trade higher on euro area issues, with more losses in Italian banks and concerns around Hungary and Spain fuelling the fire yesterday. But the employment report should be the main focus today. The unemployment rate is likely to be the main number to watch after the sharp decline last time, but the fact that this was based on labour force weakness (see spotlight below) suggests risks of a retracement. The USD seems well supported in most scenarios for the moment, but will probably respond more positively against most currencies to a weak rather than a strong number (JPY excepted). If anything, a weaker than expected number looks more likely as the strong ADP number yesterday will have raised expectations but is probably seasonally distorted.

EUR

The EUR remained weak across the board yesterday, with concerns about Spanish property loans, Hungary, and Italian banks all contributing to already weak sentiment. There is little reason to expect a turn today, whether the US numbers are strong or weak, except for a possible reluctance to head into the weekend too short EUR. Euroarea sentiment data and German factor orders numbers will be of some interest in the morning, but neither release seems likely to change the mood.

GBP

Much better than expected UK PMI services numbers failed to help sterling yesterday, partly because the Q4 GDP numbers still look unlikely to be better than flat because of the weak October reading that has started the quarter on the back foot. The December data was also probably helped by comparison to a weather affected 2009 and 2010, but there is also some evidence of genuinely better activity in December within the numbers. Even so, sterling is something of a sideshow at the moment, with EUR/GBP highly correlated with EUR/USD, and this seems likely to persist today.

CAD

In spite of a much stronger than expected IVEY PMI number yesterday, the CAD was dragged back by the generally negative sentiment engendered by euro area news. Today's Canadian employment numbers could help correct this if they reverse some of the weakness seen in the last couple of months. With the oil price also relatively firm in spite of the risk negative tone, the CAD ought to outperform other risk positive currencies.
Spotlight – Unemployment rate the main focus – US unemployment fell sharply to 8.6% last month, but the decline was primarily because of a decline in the estimated labour force rather than a rise in employment.

The combination of a static labour force (essentially unchanged since 2008) and recent weakness in productivity growth has mean that relatively modest US GDP growth in the last couple of years has been enough to bring unemployment down from more than 10% in October 2009 to 8.6% now. This is still very high by US standards, but is lower than would have been expected by most if they had been told that GDP growth in 2010 and 2011 would average 2.5%. There is a risk that the unemployment rate moves straight back up if the labour force recovers this month, but the subdued growth in the labour force is the best hope that unemployment will fall fast enough to get the Fed acting as soon as 2013.