Weaker than expected job growth in the month of September prompted investors to sell the dollar, driving it to a 2 year low against the euro. Less than 150k jobs were created last month (148k to be exact) and while the unemployment rate dropped to a nearly 5 year low of 7.1% from 7.3%, the market ignored the improvement choosing instead to hone in on the sluggish pace of job growth. Not only did the U.S. dollar weaken but 10 year Treasury yields also fell from 2.6% to 2.54% after NFPs. The S&P 500 on the other hand climbed to fresh record highs on the belief that today’s report ups the odds of Fed tapering in 2014 versus 2013. Last month, the central bank said they are looking for more broad based improvements in the economy than the drop in the jobless rate because the decline was not consistent with the performance of the rest of the economy. This tells us that lower unemployment without stronger payrolls is not the right mix for the Fed as the former is being distorted by labor force participation, which is at a 35 year low. Average hourly earnings growth also slowed to 0.1% from 0.4% the previous month. The only good news was that the 24k upward revision to the August report took away some of the sting.

However the problem for the Fed is that job growth slowed in September and the next 2 reports will be distorted by the U.S. government shutdown. The October numbers should be weak but the November numbers should be strong as Americans return to work and U.S. corporations unfreeze their expansion and investment plans. The next jobs number will be released in 2.5 weeks and we will get to see how much damage political paralysis had on the economy. The October report will be particularly vulnerable to revisions and for all of these reasons, the Fed will find it very difficult to legitimately pull the trigger on tapering before the end of the year. As Fed President Evans said yesterday, it could take a few months to sort out the U.S. labor market picture. However they will need to taper soon if the unemployment rate continues to fall at its current pace, the 6.5% target could be reached in the first half of the year if not sooner.

For the time being, we expect rates to remain suppressed into December, putting continued pressure on the greenback. If tomorrow’s Eurozone PMI reports are strong, the EUR/USD could rise above 1.3800. USD/JPY reversed its earlier slide on EUR/JPY buying but we expect to see the pair revisit 97 before the end of the year. We expect the dollar to remain weak but we don’t anticipate a full fledged collapse because tapering is still set to begin in early 2014. The timing hinges upon whether Yellen feels that they can wait to see how debt negotiations play out in January / February before reducing asset purchases.

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