December 6th could well have turned out to be the last meaningful day for the markets in 2013. A lacklustre US non-farm payrolls report would have quashed the apparently small chance of a December QE taper.

But it didn't turn out that way. November saw 203,000 jobs created, above the consensus estimate of 185,000 and the strongest back-to-back gain since February-March. Private sector employment rose by 196,000, and improvements were seen in both service and non-service sectors.

Perhaps even more eye-catching was the change in unemployment. The unemployment rate dropped to 7% from 7.3%, a far bigger fall than expected. The participation rate remains low but it actually increased in November, which was also a surprise. Previous declines in unemployment were explained by falls in the participation rate. This doesn't appear to be case in November.

Overall, it was an undoubtedly robust report, and in recent times strong labour market data can only drive markets in one direction - down. Monetary policy is explicitly linked with labour market performance, and the dreaded QE taper moves closer to becoming a reality with every solid set of jobs numbers.

But the markets didn't read that script today, and the reaction was once that had more in common with the time before extraordinary central bank intervention. The Markit iTraxx Europe rallied 2bps to 81bps, while the Markit CDX.NA.IG also tightened by 2bps to 70.25bps.

What can explain this apparent reversion to normalcy? One argument is that although the jobs report was strong, it wasn't strong enough to bring forward expectations of QE tapering. The 203,000 wasn't an outlier. Inflation remains subdued, and the Fed will wait for further evidence of growth before acting.

An alternative theory is that the NFP makes it likely that the Fed will indeed begin tapering in the coming weeks but this isn't the disaster many suppose. The markets were well positioned for a solid jobs report - both European and US spreads widened over the past few days. Under this theory, Fed action will remove uncertainty from the market and allow participants to focus on fundamentals and the gathering momentum in the economy.

Both views have merit, though it does seem strange that the markets would become comfortable with QE tapering given the bout of volatility this summer. Even emerging markets, probably the most vulnerable asset class to a Fed policy shift, rallied today. The Markit CDX.EM rose to 109.41 (price) from 109.09, still down on the year but up from the lows reached during the summer "taper tantrum."

Whichever theory has more credence, it is clear that the run-up to year-end will not be the procession many supposed. The Fed policy meeting in less than two weeks will be one of the most closely watched for some time, and the markets will probably be in a nervous state as they await the decision.

Download full article