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Are Non-Farm Payroll Expectations too Frothy?

Last updated 12/3/2009 1:51 PM ET (GMT -5) 3 Comments

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Kathy Lien

Director of Currency Research, GFT

The service sector ISM report released this morning was the last piece of the puzzle for predicting Friday’s non-farm payrolls number.  On the day of Bernanke’s confirmation hearing, the return to contractionary conditions in the service sector is a blow to his credibility but when it comes to predicting NFPs, what we care about is the employment component of that report which increased marginally in the month of November.  This suggests that job losses moderated but with some traders looking for payrolls to drop by less than 100k, market expectations may be too frothy.  The sell-off in the U.S. dollar and the resilience of stocks indicates that traders are looking for an improvement in NFPs but the hesitant move also implies that they want to wait to see that job losses recede before adding to short dollar positions.  

The following chart illustrates the strong correlation between nonfarm payrolls (white line) and the employment component of service sector ISM (orange line). Based upon this pattern, the improvement in NFPs should be minimal.  

  Leading Indicators Point to a Positive Report

The reason why job losses are expected to moderate is because 7 out of the 10 indicators for non-farm payrolls that we follow support a stronger number.  However 3 of the most important (service ISM, ADP and Consumer Confidence) rose only modestly which is why we believe that the improvement in payrolls could be small.  In fact, we would not be surprised if non-farm payrolls fell by more than 150k in the month of November because the only unambiguously positive improvement was in jobless claims.  

Arguments for Stronger Payrolls Report

1. Employment Component of Service ISM Rises to 41.6 from 41.1

2. 4 Week Average Jobless Claims Below 500k, Weekly Claims Hits 1 Yr Low

3. Challenger Reports 72.3% Drop in Layoffs

4. Continuing Claims at 5.465M Compared to 5.651M

5. ADP Reports Private Sector Job Losses at -169K, Lowest Since Aug 2008

6. Conference Board Consumer Confidence Rises from 48.7 to 49.5

7. Zero Strike Activity

Arguments for Weaker Payrolls Report

1. Monster.com Employment Index drops one point

2. Employment Component of Manufacturing ISM Drops from 53.1 to 50.8

3. Steep Fall in University of Michigan Consumer Confidence Survey

What Is the Market Expecting?

Here are the forecasts for November Non-Farm Payrolls:

  The Bar is Set High for Payrolls – Jobless Recovery

The bar is set high for Friday’s non-farm payrolls report as the market expects the smallest amount of job losses in 25 months.  The consensus forecast calls for non-farm payrolls to fall by 125k, but actual economist forecasts range anywhere from -30k to -185k. This means that as usual, the only thing that we can be certain of when it comes to the market’s reaction to NFP is volatility because given the wide range of forecasts someone is bound to be surprised.  The jobless rate will also be important now that it has breached the 10 percent mark because if it falls, everyone will begin to wonder if unemployment has finally peaked.    With a jobless rate of 10.2 percent, it has become harder to believe that, with stock markets flying higher and indicators showing strength, that the economy is about to exit one of the worst economic storms since the Great Depression. Unfortunately, even at this point, it seems that we have a long stretch ahead before any sustainable signs of job growth will be seen. After all, monthly NFP have yet to show even consistent signs of improvement, let alone growth. Employers have adapted very quickly to the new environment by expanding worker productivity in an effort to avoid hiring in an uncertain marketplace. In addition, even with the productivity gains, there is a lot of slack that can be fulfilled just by increasing the work week of employees lucky enough to keep their jobs.  Central bankers aren’t even convinced that we will see a meaningful improvement in the labor market.  Bernanke said this morning that unemployment will remain high for a long time. Therefore, while growth and optimism may be returning this could be a jobless recovery.

How Long will it Take to Return to Positive Job Growth?

Historically, it takes an average of 2.27 months for job growth to return after a recession. The National Bureau of Economic Research will not officially date the end of this recession until months from now, but based upon the GDP data and comments from Fed Chairman Ben Bernanke, the recession ended in the third quarter.  However this recession may be the exception to the 2 month average because if the recession ended in September like Bernanke said, then job growth should return in December.  Given the current state of the economy, this is highly unlikely. Yet as the trajectory of non-farm payrolls improves, there is a good chance then that the U.S. economy could return to positive job growth in the first quarter.

Taking Cue from the 1980s – 23rd Month of Negative Payrolls

The trajectory of the NFP report continues to look eerily similar to that of the 1980s.  Based upon this correlation, the U.S. economy should return to positive job growth in Q1.  

How to Trade the Non-Farm Payrolls Report

Since the beginning of the year, the non-farm payrolls report has triggered a tremendous amount of volatility in the U.S. dollar.  When the last 2 NFP numbers were released, they were worst than the market expected and the U.S. dollar rallied on risk aversion.  However shortly thereafter the dollar gave back its gains but as indicated by the 2 charts below, that also failed to last.  If non-farm payrolls disappoints and falls by more than 150k, we could see this same type of price action.  If it falls by -120k or less, the dollar may rally initially against the euro but ultimately should fall as good numbers reignite risk appetite.  

The Non-farm payrolls report is a notoriously volatile piece of news to trade as revisions and expectations also impact the market’s reaction.  Traders should remember that the first reaction to the non-farm payrolls report is usually not the one that lasts for the rest of the trading day.  The following charts show how the knee jerk reaction in the EUR/USD was erased every single month.  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. So when it comes to trading non-farm payrolls, it pays to wait.

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Comments (3)

HT

December 03, 2009 at 06:20 PM ET

Thank you for excellent analysis. As always, I'm sidelined now and wait for 30 minutes after the news, then I'll go from there.

FXDragon

December 03, 2009 at 07:39 PM ET

I will buy the dollar after the release and sell it after about an hour.

stewart mitchell

December 03, 2009 at 10:56 PM ET

what kind of range are these graphs over as cannot read it? Interesting to know historically the pips movement

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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.