US Dollar: How to Trade Non-Farm Payrolls

Last updated 1/8/2009 5:41 PM ET (GMT -5) 0 Comments - Add your comment

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 STORIES IN THE CURRENCY MARKET

• US DOLLAR: HOW TO TRADE NON-FARM PAYROLLS
• GBP/USD: CUTS 50BP, MORE EASING POSSIBLE
• EUR/USD: RALLIES DESPITE WEAK ECONOMIC DATA
• USD/CAD: IVEY PMI HITS RECORD LOW
• AUD: ONLY CURRENCY TO WEAKEN MORE THAN USD
• NZD: BUSINESS PMI ON TAP
• USD/JPY: BIG DROP IN PAYROLLS COULD DRIVE USD/JPY BELOW 90

EXPECTATIONS FOR UPCOMING FED MEETINGS

US DOLLAR: HOW TO TRADE NON-FARM PAYROLLS

The US dollar is selling off aggressively ahead of Friday’s non-farm payrolls report on the fear that for the second month in a row, job losses may have topped 500k. The recent moves in the currency and equity markets suggest that everyone expects a very weak labor market report. Although the consensus forecast is -520k, the whisper number is closer to -650k to -700k. Sentiment is strongly skewed in one direction which can be dangerous considering the fact that some of the leading indicators for non-farm payrolls call for a rebound.

Labor Market to Contract for the 12th Consecutive Month

The employment component of Service sector ISM, which is one of the most reliable leading indicators for non-farm payrolls improved in December along with the University of Michigan Consumer Confidence Index. In addition, every single time that we have seen non-farm payrolls fall by more than 500k, there is a steep rebound the following month. In the past 50 years, we have had 3 cases where more than half a million jobs were lost in one month and in every single one of those cases, NFPs rebounded close to 50 percent. The improvement in service sector ISM suggests that the rebound could be seen once again in December. With that in mind however, non-farm payrolls will still be weak and the unemployment rate will rise as all of the leading indicators for non-farm payrolls point to more job losses. The main reason why the whisper number is around -650k to -700k is because private sector payroll provider ADP reported that 693,000 jobs were cut last month. Given that non-farm payrolls came out worse than the ADP report every single month last year, this has led some people to believe that job losses in December could have been the largest in 5 decades. Unemployment rolls are also continuing to grow with the 4 week average of jobless claims and continuing claims at 26 year highs. Layoffs have risen 274.5% while online job ads have declined. Despite the rebound in the employment component of service sector ISM, the index remains in contractionary territory while the record low hit by the Conference Board’s report of consumer confidence offsets the improvement in the University of Michigan data (Read our full non-farm payrolls preview ).

How to Trade Non-Farm Payrolls

The best way to trade the non-farm payrolls report may be to actually avoid it. The report is notorious for inducing a lot of volatility particularly if there are sharp revisions to the prior month’s data. However for those traders that insist on taking a position, it is important to realize that a negative non-farm payrolls reading alone will not hurt the US dollar. Instead the greenback’s reaction to the labor market report will depend on the severity of job losses. The consensus forecast is currently -520k. Therefore if non-farm payrolls fall by 525k or less, we could see a bounce in the US dollar because these days matching expectations can be more positive than negative for a currency. If payrolls fall by more than 575k however we could see the dollar extend its losses, particularly against the Japanese Yen and Euro. The larger the decline in payrolls, the greater the potential sell-off in the US dollar. If NFPs comes anywhere close to 700k, the EUR/USD could surge towards 1.40 and USD/JPY could break 90.

Jobless Claims, Same Store Sales and Obama

Jobless claims for the week ending January 3 rebounded significantly. The market had expected claims to balloon to 545k but they rose by only 467k. The improvement has been largely attributed to seasonal factors since continuing claims surged to 4.6 million. This means that 4.6 million people are currently claiming unemployment benefits, the highest since 1982. It is not surprising then to see consumer spending contract - same store sales fell 1.7 percent last month. As a part of his economic stimulus plan, President-Elect Barack Obama has pledged to give a $1000 tax cut to 95 percent of working families. This is a good start, but it was not enough to turn around bearish dollar sentiment.

China Losing Taste for US Debt

In our 2009 Currency Market Forecast , we warned about the potential risk of a run on the dollar and in today’s NY Times there is an extensive article talking about how China is losing its taste for US Debt. The crux of the article is that China needs money to stimulate their own economy but even if their purchase of US debt slows, it will not stop because they want to avoid hurting the US’ chances for an economic recovery.

GBP/USD: CUTS 50BP, MORE EASING POSSIBLE

As you may know now, the Bank of England cut interest rates by 50bp to 1.50 percent, an all time record low for the 300 year old central bank. What we found most interesting about the BoE Monetary Policy Statement is the credit that they are giving to the weak sterling. “But the substantial depreciation in sterling over recent months may help to moderate the impact on UK net exports of the slowdown in global growth.” This is one of the arguments that we gave in my 2009 British Pound Outlook about why we expect the UK to be one of the first countries to recovery from the global economic downturn. As for further rate cuts from the central bank, more is likely given the pessimistic tone of the BoE statement. Inflation is also expected to ease sharply. UK producer prices and industrial production are due for release tomorrow. Price pressures should remain soft, but the improvement in manufacturing PMI last month suggests that the pace of contraction in industrial production may slow.

EUR/USD: RALLIES DESPITE WEAK ECONOMIC DATA

The weakness of the US dollar drove the Euro higher despite disappointing economic data. The final figures for Eurozone third quarter GDP was right in line with expectations, but confidence plunged. Consumers and businesses grew more pessimistic in the month of December as the Eurozone economy weakened. German factory orders also dropped 6.0 percent, pushing the country into a deeper recession. The calls for a January rate cut from the European Central Bank are growing but as recently as this week, Trichet remained uncommitted to a rate cut. In the past, Trichet has prepared the market for any potential changes to interest rates, but this time he has remained muted on the central bank’s plans. This suggests that he is either very serious about leaving interest rates unchanged or he is divided on what to do. Either way, a pause next week will only be a break before rates are reduced once again. German retail sales, Eurozone retail sales, German and French industrial production are due for release tomorrow. Weaker numbers are expected all around but with US non-farm payrolls due for release, any Euro bearishness will probably be expressed in the crosses rather than the major currency pair.

USD/CAD: IVEY PMI HITS RECORD LOW

The Canadian and New Zealand dollars gained strength against the greenback while the Australian dollar remained unchanged. Manufacturing conditions in Canada was the weakest ever but the deterioration was not as bad as the market had expected. The IVEY PMI index fell from 40.2 to 39.10. The employment component of the report also eased modestly. The market expects Canadian employment to drop for the second month in a row, driving the unemployment rate to the highest level in 2 years. There was no New Zealand economic data released but manufacturing PMI is due this evening. Weaker economic data caused the Australian dollar to underperform. Construction sector PMI dropped from 32.0 to 30.9, building approvals plunged while the trade surplus narrowed more than the market expected. This triple blow caused the Australian dollar to be the only currency to sell off against the US dollar today.

USD/JPY: BIG DROP IN PAYROLLS COULD DRIVE USD/JPY BELOW 90

The Japanese Yen continued to rally against the US dollar ahead of the non-farm payrolls report. Repatriation by Japanese investors is playing a big role in the currency’s strength as well as recent announcements by the Bank of Japan. The BoJ plans on supporting the nation’s banks with unlimited loans, in their latest attempting to boost the crumbling economy. They will lend approximately ¥1.22 Trillion ($18 Billion) in emergency cash in order to unfreeze the credit crunch. In return, the BOJ will accept short-term debt and commercial paper as collateral for loans which will be enforced at 0.1% starting on January 14th and ending in early April. On Friday, Japan will release its Leading Index which is forecasted to contract, confirming tougher times ahead for the economy.

GBP/USD: Currency in Play for Next 24 Hours

The currency in play for the upcoming 24 hours is GBP/USD. There will be market moving releases tomorrow starting with UK’s PPI at 9:30GMT or 4:30AM EST. Following, U.S. will announce its highly anticipated Non-Farm Payroll figures at 13:30GMT or 8:30AM EST. The British pound continued to gain strength appreciating for four consecutive days ahead of highly anticipated NFP release. After setting a 6 year low, the pound rebounded significantly and currently is trading within Buy Zone established through our Bollinger Bands. Current resistance is hovering around 1.5500 which is a 50% retracement of November high and January low. Further, the level represents a 2nd Standard Deviation of the Bollinger Bands, along with a psychological level. Our current support is placed at 1.4900, which is a 23.6% retracement of November high and January low, in addition to it being 20-day SMA. With highly volatile economic indicators being released tomorrow either of the levels could be tested.

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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.