Shocks and Surprises, Week Ending October 8th

The thing that changed this week is that for the first time since around April, it's easier to believe that the US recovery can coexist even as the household sector deleverages, than that the recovery has run out of steam. The dataflow has been quietly urging this change in assumption for the last three weeks, with positive surprises quietly outnumbering negative shocks.

The key development this week was that the repeated hints of slightly better-than-expected news from the labour market were confirmed. First, for the second week in a row the jobless data came in better than expected, with the continuing claims number printing the lowest since July – a number to match the previous week's positive surprise on initial jobless claims.

There remain questions about the impact of the seasonal adjustment process on both these numbers. However, the surprise from the weekly data was buttressed by two sets of monthly data: first, the ADP tally of monthly employment change, which came in right at the top end of expectations, and then the full monthly labour market data, in which non-farm payrolls and private-sector payrolls not only broke through the top end of expectations, but also carried with it a major upward revision (to 57k) for the previous month – you remember, the one in which the preliminary result showed no net job growth at all!

That preliminary report was, in terms of the market impact it made, probably the biggest shock of the last month. It was also, it now turns out, significantly inaccurate.

Both the perception and the reality of US job-growth matter. There's no mystery why the reality matters – it's the very stuff of economic growth. But in a recovery circumscribed by household debt-deleveraging, the perception also matters, because a household which is worried about its employment prospects is a household with an added incentive to pay down debt whilst the going remains good. As I wrote here, on at least three crucial measures, US household balance sheets have already been rectified to states which have previously been accepted and stable. The medium-term question for the US is whether those levels can remain accepted and stable in the face of the threat of severe financial turbulence. And in this, the labour market data is absolutely crucial.

Not only is the labour market delivering positive surprises, but so too was manufacturing (the ISM surpassed expectations) and construction (a rise of 1.4% MoM in August offsetting the 1.3% MoM fall recorded in July, with the numbers jostled by the impact of the near-shutdown of government contracts towards the end of July). Elsewhere, factory orders and wholesale inventories data neither surprised nor shocked.

Most probably, global markets have yet to react to the change in rational expectations about the US economy, since they remain focussed on the Euro-drama. And there, markets remain avid for a reason to believe that Euro-policymakers will or can act constructively. Perhaps this week genuinely brought some hope, in the form of a break-up of the Franco-Belgian bank Dexia. This may have allowed enough reality to intrude on European state-rooms that sensible conversations can finally be possible. Thus, the week ended with a fairly open row between the French and German governments about who is to pick up the tab for French banks' bad assets.

Arguably, the inability to articulate this core impasse, this core conflict of financial interests (let alone surmount or resolve it), has inhibited European politicians from thinking clearly about the real issues they face.

Meanwhile, the economic newsflow from Europe this week was, on balance, better than the market had expected. From within the Eurozone, manufacturing PMIs for Germany and Italy came out surprisingly better than the flash estimates, and the French trade deficit improved unexpectedly, thanks to a surge in exports of transport goods. Outside the Eurozone, Britain had a surprisingly strong week, with PMI for both manufacturing and services confounding expectations, as did service industry activity. Yes, there were negative shocks too (German and French services PMI, UK construction), but it's been a couple of months now since the good news outweighed the bad.

It was a quiet week for Asian data, mainly because Chinese markets were closed for the National Day Holiday week. Probably the most important piece of data came from Japan, where although the quarterly Tankan indexes of business conditions held no major surprises, the accompanying survey of investment intentions did, with the planned capex growth of 3% by large companies this FY coming in significantly below expectations.