Strong German Labor Market Boosts Yields, Euro, and Equities

How Did the Markets React?

Conditions in the Euro-zone’s largest economy unexpectedly brightened in October, as the German labor market tightened even further. The number of unemployed Germans dropped 67K in the month of October – far more than the expected decline of 23K – bringing the unemployment rate down to a two and a half year low of 10.4 percent. While German fixed income, equities, and FX markets all reacted in the “correct” manner to signs that the Euro-zone economy is continuing to improve, the significance of the moves were tepid ahead of the European Central Bank monetary policy decision. Though the central bank wasn’t expected adjust rates from 3.25 percent, traders anxiously awaited commentary by ECB President Jean-Claude Trichet for hints of a December hike to 3.50 percent.

Bonds – 10 Year German Bunds

While prices on German government bonds clearly declined over the course of the European morning, the shift was marginal, as price only slipped from 102.21 down to 102.14. However, the pullback in bunds came following six days of increases as traders finally went back to pricing in a hawkish ECB. The move was a result of indications that the German labor market tightened further in October, as unemployment dropped a greater-than-expected 67K to 10.4 percent. Price moves were capped at 102.14, however, as the fixed income market awaited commentary from ECB President Jean-Claude Trichet.  

FX – EUR/USD

The FX reaction to the better-than-expected German labor market data was by far the swiftest and most “correct”, as EUR/USD traded continuously higher following the release. With the unemployment rate in the Euro-zone’s largest country down to a two and a half year low, it became clear that economic expansion had not yet let up in the fourth quarter of 2006. Additionally, the change backed the ECB’s assumptions that the Euro-zone is resilient enough to weather further monetary policy tightening. Gains by the EUR/USD pair were limited, however, ahead of the ECB’s November rate decision this morning. Although the central bank was widely expected to keep rates steady until December, the markets were hesitant to trade heavily ahead of ECB President Jean-Claude Trichet’s speech and subsequent commentary regarding the economy.

Equities – Xetra DAX 100 Index                                                                     

After gapping lower at the market open on the back of declines in US indices yesterday, European bourses fought their way higher on a combination of solid earnings reports and improved European fundamentals. Technically, the equity market response was correct in relation to today’s German economic data, but the heart of the reaction was much more likely a result of corporate news. The German drugs and chemicals manufacturer, Altana, gained 3.1 percent to 45.95 euros after reporting a better-than-expected 19 percent gain in nine-month core earnings on a strong performance in its chemicals division. Meanwhile, Fresenius, the parent of German dialysis provider Fresenius Medical Care, rose 2.8 percent to 144.99 euros after broker upgrades followed the care group’s third-quarter results. Shares in Fresenius Medical Care rose 1 percent to 105.37 euros.

However, even solid corporate earnings weren’t enough to boost the DAX over yesterday’s close, as the index was still down 0.1 percent to hit 6,287.68 during the European afternoon. Share prices may have a tough time gaining momentum throughout today following hawkish commentary from ECB President Jean-Claude Trichet, as he set the stage for at least one more rate hike for the Euro-zone to 3.50 percent.