Tags: Analysis. Forex Market | Non-Farm Payrolls

Hold onto your hats on Friday because it is going to be an extremely volatile trading day. Non-farm payrolls is the most market moving economic release for the foreign exchange market and this month, the conflicting ADP and ISM reports and the wide range of forecasts ensures that someone will be surprised. 

Although the consensus forecast is for payrolls to rise by 150k, one large financial institution’s NFP model is predicting a payroll print of a dizzying 580k! With a number of leading indicators for non-farm payrolls flashing signs of slower job growth, it is hard to believe that non-farm payrolls could exceed 250k, let alone 500k. However, job growth in November was very weak contradicting all other labor market indicators that month and a “payback” in December is expected. Since the beginning of the month / year, the dollar has rallied significantly and the sustainability of its gains hinges upon Friday’s non-farm payrolls report. The only reason why investors bought dollars over the past week is in anticipation of strong job growth so if payrolls disappoint, the dollar will come crashing down. Yet given the low level of jobless claims and the strength of the ADP employment report, the dollar rallied today because the risk of a shortfall is small while the risk of a blowout number is large. 

Non-Farm Payrolls Looking Good, but How Good?  

We believe that non-farm payrolls will rise somewhere between 250k and 295k, which is more than the consensus forecast and less than the ADP print. Although ADP has done a poor job of forecasting the absolute amount of private sector payrolls, directionally they have been fairly accurate. Also, we shouldn’t completely discount the fact that more than 90 percent of the increase in payrolls was in the service sector. Jobless claims also declined significantly last month and the fewer job losses are expected to have translated into more job growth last month. However the 500k forecast is overly optimistic by all counts, especially when the “model” used to predict it is based upon the ADP (and ISM) numbers. Although the service and manufacturing sectors saw slower job growth, they are still reporting job growth and not job losses. Online job ads declined materially last month but this was largely due to end of quarter, end of year seasonal factors. As a result, we expect non-farm payrolls to rise by the most since May, but fall far short of the 500k “whisper number” floating through the market. 

Here are the forecasts for the December Non-Farm Payrolls Report:

Change in Non-Farm Payrolls:                       150K (39K Previous)                         

Unemployment Rate:                                       9.70% (9.80% Previous)                   

Change in Private Sector Payrolls:               175K (50K Previous)

Change in Manufacturing Payrolls:               5K (-13K Previous)

Average Hourly Earnings (MoM):             0.20% (0.00% Previous)

Average Weekly Hours:                                   34.3 (34.3 Previous)

Arguments for Better Non-Farm Payrolls:

1.     ADP Reports 297K Jobs Added in Private Payrolls

2.     4-Week Average Claims Declines

3.     Continuing Claims Slightly Better than Prior Month

4.     UMich Consumer Confidence hits 6-month high

5.     Challenger Reports Layoffs Decrease 29% in December

Arguments for Weaker Non-Farm Payrolls:

1.     Employment Component of Service Sector ISM Falls

2.     Employment Component of Manufacturing Weakened slightly

3.     Conference Board Consumer Confidence falls short of expected

4.     Monster.com Index Falls to Lowest Since March

Scenario Analysis: How the Dollar Could React to Payrolls

The 580k hyperbolic forecast has caused many foreign exchange traders to position for a very strong non-farm payrolls report. Interestingly enough, the price action in the equity and bond markets indicate that these traders don’t buy the lofty forecast. Most forex traders probably don’t expect such a blowout number but it is reasonable to assume that a large number of those traders expect payrolls to exceed 250k and possibly even 300k. This is the bar that the market will be measuring non-farm payrolls by tomorrow and not the 150k consensus forecast. As in recent months, the private sector payroll number will be more important than the headline but these two numbers are not expected to diverge significantly. We expect the dollar to rally as long as non-farm and private sector payrolls exceed 250k but the extent of the dollar’s gains will hinge upon the strength of non-farm payrolls.  Anything short of 250k will probably leave the market disappointed and a number weaker than 150k will cause the dollar to fall. The non-farm payrolls report is a notorious for triggering sharp volatility across the foreign exchange market and we don’t foresee a scenario that will leave the dollar unchanged post NFPs. As usual, USD/JPY will have the cleanest reaction to the non-farm payrolls report while high beta currency pairs such as the EUR/USD, GBP/USD and AUD/USD will respond to risk appetite.  It will also be important to watch for revisions – the November number was surprisingly weak which means an upward revision is possible. 

The dollar could react to the payrolls report in many different ways but here are the five most likely scenarios:

Don’t Forget About the Fed

Although a strong non-farm payrolls report could help the dollar hold onto its gains for the next few weeks, it is important to remember that the Federal Reserve is still very far away from normalizing, let alone tightening monetary policy. In the December FOMC minutes, the central bank reminded us that their dual mandate is maximum employment and price stability. Maximum employment is a very high bar that will take a long time to meet and for this reason even if payrolls are very strong, the Fed will err on the side of caution and wait to see if the strength is sustained another month or two before even considering reducing their asset purchase program. We still believe that the central bank will leave interest rates unchanged for a good part of 2011 and as a result, once the market shakes off its initial optimism about a strong NFP report, good U.S. data could be more positive for risk than for the dollar. Over the past decade, the Federal Reserve has held off raising interest rates until the unemployment rate has fallen for at least a few months. Given the high level of unemployment and the fact that the jobless rate ticked higher in November, a rate hike is not something that the U.S. central bank is even considering at this time.