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Chandler: Don't Get Overly Optimistic Just Yet

The stronger-than-expected US employment report combined with the comments of two Fed officials in the past 24 hours (Hoenig and Lockhart) about not waiting too long to hike rates has seen the Fed funds futures sell-off sharply.

The December futures contract is now implying an effective Fed funds rate of 47 basis points. The September contract is implying a 28 basis points effective average.

There are hawks at the Fed and they have had been beaten into submission by the crisis. The market is probably getting ahead of itself in terms of tightening and reducing the fiscal stimulus. The only thing that has happened is that the pace of decline has slowed.

What green shoots there are, are terribly fragile.

Our big picture view has been that the aggressiveness of the US policy response, coupled with the unprecedented pace that businesses have slashed inventories and fired workers (faster than output has fallen) boosts the chances that the US recovers first and strongest of the major industrialized countries and can be the first to exit or unwind the quantitative easing.

However, while we would like to embrace today's price action as what we had been looking for, we are reluctant to do so. Many economists are questioning the birth/death model, which is used to forecast jobs created/destroyed by businesses too small to be picked up in the surveys. Of the unseasonably adjusted job creation, this birth/death figure may account for nearly three quarters of the jobs.

There seems to be other rogue rumors trying to undermine the credibility of the jobs report. Many will argue that one swallow a spring does not make. At the same time, note that yesterday, continuing claims edged lower for the first time and this also points to some stabilization of the jobs market.

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The aggressiveness with which businesses have slashed employment has resulted in constructive productivity figures. Earlier this week the government doubled its initial estimate of productivity growth in Q1 from 0.8% to 1.6%. For the record, the 20-quarter moving average is 1.78%. It is possible that given this unusual increase in productivity during the economic downturn, that employment may not lag as much as it has in other cycles.

There is little US economic data at the start of the week that will allow the testing of the hypothesis that the relationships have changed and that the dollar will respond positively to good news. Short-term operators may try to anticipate, while the medium and longer-term investors may chose to wait for clear signals.

The retail sales report next Friday (June 11) may be the first real test. Auto sales were stronger than expected. Gasoline prices rose in the month. But these positives have been blunted by the disappointing chain store sales. In lieu of the data, expect forex participants to watch the equity market even closer in the days ahead.

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Marc Chandler is the global head of currency strategy for Brown Brothers Harriman. He has been analyzing, writing and talking about the foreign exchange market for more than 20 years. He is a regular guest on CNBC and his essays have been published in numerous economic and business publications. He previously served as the chief currency strategist for HSBC Bank USA and Mellon Bank.