Disappointing jobs data drove the U.S. dollar sharply lower against all of the major currencies and based on the price action across the financial markets, investors no longer believe that the Fed will taper this month. Equity futures, gold and bond prices have soared with U.S. yields falling and this consistent reaction is a function of investors paring back their bets on tapering. Were the numbers really that bad? Yes.

Non-farm payrolls rose 169k in the month of August, only slightly less expected but the real sucker punch came from July revisions. The labor department revised down its July estimate for payrolls from 162k to a 104k and while the unemployment rate dropped from 7.4% to a 4.5 year low of 7.3%, the decline was driven largely by the lowest labor force participation rate in 35 years. This is a sign of weakness because a lower participation rate means that people are dropping out of the workforce and no longer being counted in the household survey.

However the weak jobs number does not completely eliminate the possibility of a change in asset purchases this month. We know there is a high level of support inside the central bank to reduce asset purchases and the only question is timing. With the recovery in bond prices and fall in U.S. yields, there may not be a better time for the Fed to taper. Yet even if they stay on course, any changes in monetary policy will be symbolic which means an incremental reduction wrapped by a dovish FOMC statement to prevent a rebound in yields. Between the slowdown in the labor market recovery, debt ceiling debate and geopolitical tensions, the Fed could also delay their changes to December but the proximity of the holidays and end of Bernanke’s term makes this option less palatable.

We don’t believe that tapering in September is off the table but more investors will need to adjust positions to account for the lower probability, which makes further dollar weakness a likely scenario. If bond yields fall alongside the dollar, U.S. stocks could enjoy a stronger recovery.

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