U.S. Employment Looks Promising but Risks Remain
Figure 1: U.S. employment and payroll change rates
February was the third consecutive month where U.S. jobs grew by over 200,000. According to the U.S. Bureau of Labor Statistics, nonfarm payroll employment rose 227,000 in February. And with figures for December and January revised upwards by 20,000 and 41,000, respectively, the strong data for February could even be revised upward in the next report. These new hires are encouraging consumers to spend more and deleverage faster by paying off past debts. Retail sales and consumer spending improved in early February to their highest level in five months, despite rising gasoline prices, according to the Commerce Department. February sales rose a higher-than-expected 1.1%, which come atop of a 0.6% increase in January. January consumer confidence also rose to a four-year high in early February, with the University of Michigan consumer sentiment index reaching 75.3. Given the broad increases seen across many sectors, the building momentum bodes well for the recovering U.S. economy.
Finally, the U.S. housing market is showing a few signs of a structural recovery. While home prices have continued to fall, construction and home sales have started to recover. A recent industry survey also found that confidence in the housing market maintained its levels near five-year highs, with a reading of 28.0, according to the National Association of Home Builders. And increased consumer credit could help shore up the market even further.
SEE: Why the Consumer Price Index Is Controversial
Europe Situation & Inflation Pose Risks
But despite the positive outlook, the market only needs to look back one year to see the risks that remain. Last spring, the U.S. enjoyed a similar three-month run of job numbers over 200,000. The streak ended with the brutal combination of a European crisis, Japanese catastrophe, rising oil prices and bickering politicians, among other issues. Threats this time around include the same European crisis, escalating oil prices and complacent lawmakers.
Signs of these cracks in the economy may already be starting to show. The early-March University of Michigan consumer sentiment index fell from 75.3 (mentioned above) to 74.3, despite economists projecting the figure to rise to 76. Consumer inflation also increased by 0.4% in February, in line with estimates, as gas prices continued to move higher, eating into consumer discretionary spending. Finally, the Federal Reserve reported that industrial output was unchanged in February when economists were expecting a 0.4% increase.
What to Look for Ahead
Some key areas of focus for forex traders are the U.S. unemployment report due out on April 6 and the next Michigan consumer sentiment index due on March 30. If the situation shows signs of improvement, bucking the trend seen around the rest of the world, the dollar could see further appreciation, as an interest rate hike could come sooner. But any unexpected decline in the figures could lead to a dollar sell-off and renewed concerns of a more serious slowdown.
SEE: The Unemployment Rate: Get Real
Europe Situation Defused but Not Out of the Woods
Figure 2: Greece Projected Real GDP
Greece completed an important first step in restructuring its debt in March, but the country isn't out of the woods quite yet. Under the debt agreement, private-sector investors agreed to swap their old bonds for new ones, with less than half of the face value, reduced coupons and longer maturities, which resulted in a 105 billion euro write-off for the troubled country. The agreement itself also paved the way for a 130 billion euro bailout package from the E.U. and IMF. The move even prompted some ratings agencies to take a brighter outlook on the country. For instance, Fitch upgraded Greece out of "restricted default" with a new B- rating. While the rating is still junk status, the revision has helped moderate interest rates a bit. Reports from European Union leaders suggest that the country will likely remain stagnant in 2013, but return to growth in 2014, if it succeeds in implementing key reforms.
Skepticism Surrounds Greek Implementation
Figure 3: Greece 10-year Bond Yields
Despite the positive signs, there are plenty of troubling issues that remain. European bond yields have resumed their rise in countries like Portugal and Spain, while they are hitting new lows in the safe-haven Germany. Meanwhile, Greek bonds have priced above 18% - the highest in the Eurozone - which suggests that the market remains skeptical and Greece may need at least a second debt restructuring before its problems are fully addressed. SEE: Behind The Euro: History And Future
After failing to meet target austerity demands under its old loan program, the market also remains skeptical as to Greece's ability to implement these new reforms. The IMF recently warned that the country's loan program faces "exceptionally high" risks and that a "disorderly euro exit would be unavoidable" without continued support from the Eurozone. And with all of the austerity programs in full force, it's uncertain where the capital will come from.
Contagion Remains a Threat
Figure 4: Span Debt to GDP (%)
At the same time, traders are also turning their eyes to Spain, which is potentially far more catastrophic than a Greece default. Prime Minister Mariano Rajoy recently warned that the country may not meet its deficit reduction goals by 2012 and has attempted to allay concerns by implementing a more ambitious target for 2013. Whether or not that market accepts this as reality remains to be seen, as yields continue their rise. These concerns were underscored when the country's debt hit 68.5% of its gross domestic product last year, according to data from the Bank of Spain in mid-March. The figure exceeded the government's forecast of 67.3% and compared to 66% during the third quarter. The European Commission forecasts that this number will have almost doubled to 78% of GDP by next year from where it began at the beginning of the sovereign debt crisis.
While the ECB has averted many problems with its strong liquidity program – under the new management of Mario Draghi – Spain and other periphery Eurozone countries still face many risks. The austerity plans going into effect may help reduce debt, but without growth, future debt can become even more unmanageable.
What to Look for Ahead
Forex traders will be carefully watching Greek and Spanish bond auctions for signs of rising yields that could push the countries into an unsustainable zone. Meanwhile, the market will also be cognizant of the execution of the agreement made with Greece, particularly as the country faces upcoming elections that could change its landscape. If Greece is able to hit its austerity targets, the region could recover, but otherwise, the market can expect more problems.
SEE: The History Of Greek Sovereign Debt Defaults
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