Fundamental Commentary, 10 Sept 07

Data released on Friday morning showed that non-farm payrolls fell by 4000 in August, the first monthly decline in U.S. employment in four years. Moreover, gains in June and July were revised significantly lower. Over the last three months the economy has added only 44,000 jobs per month on average, a significant slowdown from the 160,000 per month pace that was achieved earlier in the year. The dollar depreciated in the aftermath of the data release as the weaker-than-expected data reinforced expectations that the Fed would cut rates at next week's FOMC meeting. The Japanese yen was the biggest beneficiary as heightened risk aversion led some market participants to unwind carry trades. That said, the yen gave up some of its gains last night as revised GDP data showed that the Japanese economy contracted at an annualized rate of 1.2% in the second quarter. (The original estimate had showed a 0.5% growth rate.)

Does Friday's data mean that the U.S. economy is slipping into recession? Probably not. The outturn was so surprising because it was not consistent with most other recent data releases that suggest the U.S. economy continues to grow, albeit at a slower pace than a year or two ago. Although we can dismiss one month's employment number as an aberration, we should not overlook the fact that employment growth has slowed significantly. The economy is not in recession now, but the risks that it could slip into one have risen. In order to offset these downside risks to growth, the Fed likely will ease policy beginning at next week's FOMC meeting. Narrowing interest rates differentials should continue to exert downward pressure on the greenback on a trend basis.

The docket is essentially empty today. Although data on U.S. international trade in July could elicit some interest tomorrow morning, the most important data of the week won't print until Friday, when August data on retail sales will be released. Until then, the greenback likely will remain on the defensive.

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