Bar is Set High for Non-Farm Payrolls

Last updated 9/3/2009 1:29 PM ET (GMT -5) 7 Comments

Kathy Lien

Director of Currency Research, GFT

Over the past few months, one of the biggest water cooler arguments has been whether or not the U.S. labor market is really improving. Based upon the official non-farm payrolls report, we know that job losses are slowing but unemployed Americans are also having a tough time finding work and may even be at risk of losing their benefits. So how the labor market is doing depends upon what type of yardstick you are measuring things by – the word on the street or the official reports. Tomorrow, non-farm payrolls for the month of August will be released and now more than ever, the degree of job losses could have a meaningful impact on the U.S. dollar. Since the last employment report, the dollar has held near its year to date low against most currencies while stocks have held near their yearly highs. Every day the focus has shifted from faith to skepticism about the U.S. recovery and the payrolls report will help to clear the muddy waters.

The Bar is Set High for Payrolls

Unfortunately the bar is set high for Friday’s non-farm payrolls report as the market expects the smallest amount of job losses in 12 months. Thankfully, nearly all of the leading indications for payrolls point to a stronger report. The only question is, how will foreign exchange traders respond? With each passing week, dollar bears need more reason to hold onto their short positions. So if payrolls simply match expectations that may not be enough to satisfy them, especially if there are negative revisions to the previous number. Also, don’t forget that it will be a long weekend for U.S. traders - so for anyone who made money on the payrolls report, they will be encouraged to take their profits quickly and run. Trading will probably grind to a halt after 12pm NY Time if not earlier. We continue to believe that the knee jerk reaction in the EUR/USD to the payrolls report will fade just as it has over the past few months. This is discussed in further detail at the end of this report.

The Leading Indicators Point to a Positive Report

Like many economists, we are also skeptical about the sustainability of the improvement in the labor market, but the facts suggest otherwise and we always side with the facts. Every month we look at 10 leading indicators for non-farm payrolls and this month 8 out of the 10 point to smaller job losses. The employment component of service sector ISM, which was released this morning rose from 41.5 to 43.5 which confirms that in the service sector, the pace of job losses are slowing. Yesterday, payroll provider ADP reported the fewest private sector job losses since September 2008 while Challenger Gray & Christmas reported the largest decline in layoffs since February 2008. However one of the most interesting results this month was from online job board Monster.com who reported the sharpest monthly gain in their Employment Index since August 2005. This indicates that after 3 consecutive months of fewer ads, companies are hiring again. The only red flag was jobless claims which ticked higher last month. Therefore most likely, we will only see a modest improvement in non-farm payrolls and since the U.S. economy is still experiencing net job loss, the unemployment rate should rise from 9.4 to 9.5 percent.

Arguments for Stronger Payrolls Report

1. ADP Reports Fewest Private Sector Job Losses since Sept 2008

2. Challenger Reports Largest Decline in Layoffs since Feb 2008

3. Service ISM Employment Component Rises from 43.4 to 41.5

4. Manufacturing ISM Employment Component Rises Modestly

5. Consumer Confidence Rises to Highest Level since May 2008

6. Strike Activity Falls by 2,400

7. Monster.com Employment Index Rises Sharply – Biggest Monthly Gain since Aug 2005

8. Continuing Claims at 6.23M vs. 6.31M

Arguments for Weaker Payrolls Report

1. UMich Confidence Falls from 66.0 to 65.7

2. 4 Week Moving Average of Jobless Claims Rises to 571k from 555k

Taking Cue from the 1980s - 20th Month of Negative Payrolls

By now, the length of job losses has exceeded that of the recession in the 1980s. Between 1980 and 1982, non-farm payrolls printed negative for 17th consecutive months and with tomorrow’s report, non-farm payrolls in the current recession would have printed negative for the past 20 months. Yet the trajectory of the NFP report continues to look eerily similar to that of the 1980s (as indicated in the chart below). If the correlation continues, this means that we could see positive job growth by the first quarter of next year if not sooner. There is still a risk of a dip in payrolls because this is the worst recession since the Great Depression and not just the 1980s recession.

Dollar’s Reaction to Payrolls May Depend on the Pace of Improvement

In July, the Non-Farm Payrolls report increased dramatically, jumping to -247K, an almost 200K reduction in job losses in only a month. In large part it was this release that set off equity markets on an impressive late summer run and lifted much of the anxiety and uncertainty that was expressed in the marketplace. The question is: will August see the same magnitude of improvement. Unfortunately, even if the Non-Farm Payroll report improves, the magnitude will most likely be muted in comparison with last month’s report. This means that progress in the employment market is starting to slow as the benefits from Federal stimulus are starting to wear thin. Despite help on a governmental level, spending has yet to pose any sort of return which indicates that jobs remain the number one concern on the minds of the American working class. If the pace of improvement in the labor market is not large enough, it may prove to be a disappointment for currency traders.

What Is the Market Expecting?

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

How to Trade the Non-Farm Payrolls Report

The key levels to watch for the non-farm payrolls report are -200k and -300k. If payrolls decline by 200k or less, it will be very positive for risk which means a strong rally in the dollar against the Yen but weakness against higher yielding currencies such as the euro and Australian dollar. If payrolls decline by 400k or more, traders could expect a wave of risk aversion that could drive the dollar lower against the Japanese Yen but higher against the riskier currencies. Anything in between should elicit only a modest reaction in the direction of the surprise. 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. Seven out of the last eight 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 usually not sustained, and eventually reversed into a more substantial move that lasted for the course of the trading day. When it comes to trading non-farm payrolls, it pays to wait.

Evidence of the erratic trading is seen after the most recent non-farm payrolls report. The EUR/USD spiked higher by 40 pips after the upside surprise but in the next 10 minutes fell more than 100 pips in what later became a strong downtrend that brought the currency pair down 200 pips from its pre NFP levels.

EUR/USD Intraday move following payrolls report in August:

EUR/USD Intraday move following NFP in July

EUR/USD Intraday move following NFP in June

Comments (7)

il_padrone

September 03, 2009 at 04:19 PM ET

Thanks, Kathy-you lay out your reasons very clearly and your argument is a pleasure to follow.

lcfx

September 03, 2009 at 04:27 PM ET

Is the risk trade ending? From the last two months it looks like a positive report might be USD positive against the EUR do to the prospects of US economic recovery. Do you think that regardless of the data, the report will likely be USD positive (economic recovery vs. risk aversion)? Thanks Kathy. You do great work.

klien

September 03, 2009 at 05:32 PM ET

Not for now. If equities fall in Sept like they normally do, we should see the dollar rise, especially if the move is big

FXDragon

September 03, 2009 at 06:21 PM ET

Could you say which 1 month out of 8 months, the kneejerk reaction was not erased? I would appreciate if you could respond tilll the release.

thanks,

klien

September 04, 2009 at 08:25 AM ET

May

FXDragon

September 03, 2009 at 07:02 PM ET

Also, what was nfp report for may?

thank you,

Mike

September 04, 2009 at 09:41 AM ET

it's crazy payrolls ;)

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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.