What to Expect for ECB and Non-Farm Payrolls

Last updated 7/1/2009 10:26 AM ET (GMT -5) 7 Comments

Forex Trading involves high risks, with the potential for substantial losses and is not suitable for all persons. Past performance is not necessarily indicative of future results.

Kathy Lien

Director of Currency Research, GFT

The action in the foreign exchange market heats over the next 24 hours with the ECB monetary policy decision and the U.S. non-farm payrolls report due within an hour of each other. Individually, either of these event risks could set the tone for trading for an entire month, and collectively, they could be a double whammy for the currency market.   At the last ECB meeting in June, the central bank unveiled a relatively conservative covered bond purchase program and for this meeting, the market will be looking for signs of whether the program will be extended. In terms of Non-Farm Payrolls, the big question is whether last month’s sharp improvement can be sustained.  Only 345k jobs were lost in the month of May, compared to -504k the prior month. The good thing is that there should be a lot of leeway for the payrolls report because a dip is natural after such a large rebound. In fact, the currency market’s reaction to the ADP number this morning could be symbolic of how the dollar could trade after the payrolls report. When the payroll provider reported that -473k people fell off of corporate payrolls, the dollar soared on risk aversion flows but it quickly reversed after traders realized that as long as job losses are less than 500k, it still represents a material improvement from January 2009 levels. If job losses exceed 500k however, it could resurrect the risk of a double dip recession. 

Let’s take a look at each of these events separately to get a sense of what to expect.

ECB Preview: Which Way Will the ECB Lean?

There is no question that the European Central Bank will keep interest unchanged at a record low of 1.00 percent. Therefore the focus will be on the press conference delivered by Trichet, which begins at 8:30am ET. The reaction in the EUR/USD will depend upon which way Trichet leans. Will he talk about an exit strategy or will he leave the door open for further easing? From an economic perspective, the Eurozone economy remains weak but certain sectors of the economy has been improving. Businesses and consumers have grown more confident which is the first step towards any type of recovery. German retail sales also increased for the third straight month in May. However there is plenty of weakness all around. The unemployment rate is still rising as manufacturing and service activity continues to contract, albeit at a slower pace. The ECB just reduced their growth forecasts last month and unfortunately the region is not expected to return to positive growth until next year. With German consumer prices rising only 0.1 percent on annualized basis in June, inflation is also negligible. Therefore the ECB will most likely say that the risks to inflation are balanced but commodity prices leave the risk to the upside. 

We will also be watching for Trichet’s comments on the results of the first ever 12 month refinancing operation which pumped a record amount of money into the financial system.  The operation was a great success in that it successfully pushed rates lower and therefore the ECB will most likely coast on that for a while because in their eyes, they have done all that is necessary for the time being. We expect Trichet to reiterate that monetary policy is appropriate, leaving all options open. Last week, ECB member Weber, who also heads up Germany’s Bundesbank said the central bank has used up its room to cut interest rates which is probably true, but Trichet may not go so far as to repeat that. Also, since the ECB just started its quasi Quantitative / Credit easing program last month and economic data has been mixed, we expect the central bank to still be considering increasing rather than decreasing monetary stimulus. If the market believes that Trichet has reserved the option to increase their asset purchases, the EUR/USD could give back its recent gains. If he openly talks about extending the size and scope of program, it would be bearish for the EUR/USD but if Trichet suggests that he has done enough, which we expect him to do, the EUR/USD could extend its gains. Of course, how the market trades at 8:30am ET tomorrow morning will also largely depend upon the U.S. non-farm payrolls report. 

Non-Farm Payrolls Preview: Will Payrolls Follow 1980s Trajectory?

Last month’s non-farm payrolls report elicited smiles across Wall Street when traders learned that 345k jobs were lost, far less than the market’s 520k forecast.  Although the unemployment rate breached 9% for the first time since 1983, hitting a 25 year high of 9.4 percent, it signaled that the labor market has hit a bottom. Tomorrow’s non-farm payrolls report will be critical in confirming whether the hemorrhaging is over or if the improvement was only a one month fluke. Based upon our leading indicators for non-farm payrolls, we believe that job losses accelerated last month but only marginally. There has been a lot of good news including the Challenger layoff report which showed the first decline in layoffs since February 2008 and the rise in the employment component of manufacturing ISM.  But it is natural to see a dip after last month’s sharp improvement especially since the closing of GM and Chrysler plants will add approximately 40k-50k people to the unemployment rolls. Our forecast is for payrolls to fall between 375k and 450k. 

Non-Farm Payrolls Follows 1980s Trajectory

According to the following chart, the latest trend of non-farm payrolls is incredibly similar to that of the 1980s (X axis: 1 equals the first month of job losses). Back then, the economy returned to consistently positive job growth 20 months after the first month of job losses. In the current recession, the job losses began in January 2008 and even though we are still months from experiencing positive job growth, January 2009 will go down in history as the month with the single highest job losses during the 2008 Great Recession. However with that in mind, we could still see job losses take another nosedive on its way back towards positive territory. 

So what makes us believe that non-farm payrolls will only see a mild decline? 

Every month, we take a look at ten leading indicators for non-farm payrolls. Forecasting non-farm payrolls this month is more difficult than previous months because service sector ISM is not being released until after the employment report. Of the reports that we do have, 6 out of the 9 point to smaller job losses and 2 out of the 3 that favor larger job losses only saw a mild deterioration. 

Arguments for Better Non-Farm Payrolls:

1.      Employment Component of Manufacturing Sector ISM Rose from 34.3 to 40.7

2.      Challenger Reports First Decline in Layoffs Since February 2008

3.      ADP Reports Fewest Private Sector Job Losses Since October 2008

4.      University of Michigan Consumer Confidence Matches 18 Month High

5.      Continuing Claims Off Lows

6.      Zero Strike Activity

Arguments for Weaker Non-Farm Payrolls:

1.      Monster.com Employment Index Falls One Point

2.      4-Week Average Jobless Rises Marginally

3.      Conference Board Consumer Confidence Dips from 54.8 to 49.30

Here the “charts that matter” for non-farm payrolls. 

ADP - Over the past few years, the ADP report has a history of undershooting non-farm payrolls and so the marginal improvement actually confirms our belief that payrolls was worse and not better last month. 

Source: Bloomberg

Weekly Jobless Claims are off their peak

Source: Bloomberg

What Is the Market Expecting?

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

Change in Non-Farm Payrolls:                        -365k (-345k Previous)                      

Unemployment Rate:                                         9.6% (9.4% Previous)                        

Change in Manufacturing Payrolls:                -150k (-156k Previous)      

Average Hourly Earnings (MoM):   0.1% (0.1% Previous)        

Average Weekly Hours:                                    33.1 (33.1 Previous)

How to Trade the Non-Farm Payrolls Report

For currency traders, the most important question is, how will the dollar respond? Over the past 3 months, the U.S. dollar has weakened materially, but the weakness is actually a reflection of investor optimism. We believe that the level to watch is -500k. If non-farm payrolls fall more than 500k, the dollar could sell-off initially but then quickly regain footing as risk aversion flows set in. If non-farm payrolls fall by less than 450k, the dollar could initially rally but then give back its gains as risk appetite improves.  Anything in between could lead to erratic trading. Non-farm payrolls are a notoriously volatile piece of data to trade as revisions and expectations also impact the market’s reaction. Traders should also remember that the first reaction to the non-farm payrolls report is usually not the real one that lasts for the rest of the trading day.  Six out of the last six times non-farm payrolls were released, the knee jerk reaction was quickly erased. Even though the direction associated with these instances has not always been the same, we can see that the immediate reaction is not sustained, and eventually reversed into a more substantial move that lasted for the course of the trading day.

EUR/USD Intraday move following payrolls report in June

Comments (7)

Qin

July 01, 2009 at 12:45 PM ET

Thank you for your comment and information.

Best regards
Qin

clusterFX

July 02, 2009 at 11:31 AM ET

Kathy and Boris-

I received a notice from my broker (FXCM) about no longer being able to hedge or place stop and limit orders because of NFA regulations. Can you please explain this to me and if it affects all brokers? Sorry that this is not the right article but I trust FX360's opinions in these matters and I know a lot of traders like me are confused and alarmed!

klien

July 02, 2009 at 01:34 PM ET

We are going to put up a detailed response soon

Dario Fuentes

July 02, 2009 at 02:28 PM ET

Hi clusterfc,
According to the new regulations, in fact, you can not hedge anymore, meaning that you can not have a buy and a sell position of the same pair at the same time. However, you will be able to hedge using the correlation beetween currencies. Kathy has a great article about that topic on the web, if you read it it will help you a lot. Keep in mind that this regulation is just in United States so if you choose a broker based somewhere else, this rule won't be effective.
I haven't heard anything about stop or limit orders, but if that is the case, it sounds ridiculous because risk managment is one of the most important aspects in trading.
I can not wait to read the detailed response in here to analize this issue further.

klien

July 02, 2009 at 05:03 PM ET

Here's the official response from GFT:

ADA, MICH, July 2, 2009 — While a recently adopted National Futures Association (NFA) rule is forcing some forex dealers to discontinue the use of stop and limit orders to protect positions, GFT, a US-based company, announced today that their platform is fully compliant with all NFA regulations and, as such, customers trading with GFT will not be affected.

NFA Rule 2-43 (b) requires a “first-in, first-out” (FIFO) method of trading, which simply means that orders must be closed in the order in which they were opened. In many dealers’ systems, stop and limit orders would violate this rule. The new rule also eliminates “hedging,” which is the practice of taking contrary positions in a market in the hope that one of the positions will prove profitable.

Because GFT has always had a FIFO trading system, founder and CEO Gary Tilkin said that GFT customers will see no changes to their accounts or trading strategies when the rule takes effect on August 1.
“Rule 2-43 (b) does not change anything for our customers,” he said. “We offer stops and limits today and we’ll be offering them in the future. We believe they are an important part of a sound risk management program.”

As for hedging, Tilkin believes that many traders don’t understand that the practice works against them far more often than it works for them.

“GFT has never allowed hedging on its system because we believe it’s little more than a way for dealers to charge twice for the spread on what is, essentially, a non-position.” he said. “To have two counter positions in a financial product is really no position at all, and there really is no financial benefit for the customer to engage in this type of trading.”

Because GFT’s system is net-based rather than position-based, the new rule does not apply. In a position-based system, it is possible for a trader to take multiple positions at different levels on the same market. For example, a trader could have three positions in the EUR/USD pair and then close out each position based on its individual performance, which would violate the FIFO rule.

However, in a net-based system such as GFT’s, when a trader enters a new position in a market where he or she already holds a position, the new position is simply added to the old position and the prices are averaged. So it’s not possible to hold multiple positions in the same pair and therefore it is not possible to violate the FIFO rule.

GFT has always encouraged traders to do their research and employ a sound methodology when trading currencies. Trading psychology and time-tested methodologies go hand-in-hand, and hedging strategies discourage these sound practices. To read comments made by Tilkin earlier this year on the subject of hedging and the new FIFO rule, click here.

To circumvent the new rule, some dealers are asking customers to move their accounts to divisions in the UK where the NFA has no jurisdiction. However, Tilkin questions this practice because he believes the NFA rule is designed to offer better protection for traders.

“Why would we ask our customers to move their accounts outside the US when the NFA is looking out for their best interests?,” he asked. “Ultimately, we believe that more protection is better.”

PLAYJT

July 02, 2009 at 05:29 PM ET

Kathy,

Thank You for the update...

Have a Happy Fourth!

JT

PLAYJT

July 02, 2009 at 05:58 PM ET

Kathy,

Just say on Fast Money, The Fed is going to intervene on Calif. Iou's... other words.. they are no good... delays and fee's...

JT

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About The Author

Kathy Lien began her FX trading career 10 years ago at J.P. Morgan Chase. After graduating New York University’s Leonard Stern School of Business at the age of 18, Kathy joined the bank's interbank FX trading desk and eventually moved to the cross markets proprietary trading desk. In the interbank market, her ability to create solid fundamental and technical analysis from the myriad of information on the market helped her trade forex spot and options. Her experience eventually led her to be chief strategist at Daily FX where she worked until she joined GFT in 2008.

With her knowledge of forex, as well as her experience trading other products, such as interest rate derivates, bonds, equities, and futures, Lien has built a reputation as an international currency analyst. She is frequently quoted on CNBC, Bloomberg, Fox Business and Reuters. Lien has also written for publications like Active Trader, Futures, and SFO magazine. She is the author of the newly updated Day Trading the Currency Market: Technical and Fundamental Strategies to Profit from Market Moves, and the co-author of Millionaire Traders: How Everyday People Are Beating Wall Street at Its Own Game with Boris Schlossberg.

To buy Kathy’s newly updated Day Trading and Swing Trading the Currency Market: Technical and Fundamental Strategies to Profit from Market Moves, click here.