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Non-Farm Payrolls Preview: Impact on Dollar and QE3

Last updated 10/6/2011 1:15 PM ET (GMT -5) 1 Comments

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Kathy Lien

Director of Currency Research, GFT

The Federal Reserve is at the brink of introducing another round of asset purchases. Earlier this week, Fed Chairman Ben Bernanke told the Joint Economic Committee the “Federal Reserve stands ready to provide liquidity in the U.S. through a broad-based lending program.” He sounded extremely concerned about the outlook for the U.S. economy and admitted that Operation Twist, the stimulus measure they announced last month had a “meaningful but not enormous” effect on the economy. Yet they held off on a more aggressive step last month because they wanted to monitor the developments in Europe and see if job growth would return in September.  This is the reason why Friday’s non-farm payrolls report is so important because it will determine how quickly and aggressively the Fed will need to announce QE3. In our opinion, even if job growth recovers in September, unless payrolls rise by 200k or greater, the Fed will still need to pull the trigger on more QE.

There is an old saying that everything comes in 3s and in the case of Quantitative Easing, this saying will probably hold true. The first round of QE came in November 2008. The second round was in November 2010 and the third round could come on the anniversary of the first two rounds of QE depending upon how Friday’s non-farm payrolls report fares. Non-farm payrolls are notorious for triggering sharp volatility across the financial markets but this month, the degree of job growth or lack thereof could actually lead to a major policy change which is why everyone, including the Federal Reserve will be watching the report very closely. Aside from monetary policy, the fate of the dollar also hinges upon payrolls. Up until now, USD/JPY has held above 76, but negative jobs growth, which is not completely out of the realm of possibility could cause the currency pair to fall below that level.

Last month’s non-farm payrolls report was abysmal with the Labor department reporting zero job growth. For the past 4 months, payrolls rose by an average of 39.5k per month, far below the 100k to150k jobs that need to be created each month to simply match the number of new entrants into the workforce and to keep the unemployment rate unchanged. Although most of the leading indicators for payrolls point to a rebound in the labor market, economists do not expect a significant increase. The current forecast for payrolls is a mere 55k, a level that would most certainly trigger QE3.  The monthly U.S. labor market report has long been one of the most important economic releases for the U.S. economy but now more than ever, jobs are crucial because they are key missing ingredient.

Leading Indicators for NFPs Point to Lackluster Job Growth

Nearly all of the leading indicators for non-farm payrolls point to stronger job growth but these labor market reports have done a poor job of forecasting NFPs.   The weekly jobless claims report for example has showed claims holding near 410k for the past 2 months, which is below the average claims reported between April and July. However fewer claims for unemployment benefits have not translated into job growth because fewer firings doesn’t necessarily mean greater hiring. According to payroll provider ADP, the private sector added 91k jobs in August, up from 89k the previous month. Unfortunately as seen in the chart below, ADP has been notoriously wrong in predicting private payrolls growth and has been off by at least 55k since the beginning of the year. Last month, only 17k private sector jobs were created compared to ADP’s 89k estimate.  The market has lost confidence in the ADP report as a reliable indicator for NFPs. At the same time, even though consumer sentiment improved the uptick was nominal. The manufacturing sector enjoyed stronger job growth but the service sector experienced its first contraction in the labor market in more than a year. The non-manufacturing ISM index is typically one of the most reliable leading indicators for NFP which is why we cannot rule out negative job growth. Challenger Grey & Christmas also reported a more than 200 percent increase in layoffs. Although this was largely due to the reduction in government jobs and layoffs at Bank of America, the Challenger report also points to weak job growth. 

Here are the arguments for strong vs. weak NFPs. 

Arguments for Better Non-Farm Payrolls:

1.      Employment Component of Manufacturing ISM Rises

2.      ADP Reports 91k Private Sector Jobs

3.      University of Michigan Consumer Confidence Index Rebounds

4.      Consumer Confidence Index Edges Slightly Higher

5.      4 Week Moving Average of Claims Slightly Lower

6.      Continuing Claims Decline

Arguments for Weaker Non-Farm Payrolls:

1.      Employment Component of Non-Mfg ISM Contracts for first in more than a year

2.      Challenger Reports 211.5% Increase in Layoffs

These are the forecasts for the September Non-Farm Payrolls Report:

How to Trade Non-Farm Payrolls

The big question for currency traders is how the dollar could react to the non-farm payrolls release. Investors are already short dollars against the Japanese Yen going into NFPs which means that the reaction to a weak number in USD/JPY could be limited. A strong payrolls report on the other hand could trigger a round of short covering that drives USD/JPY back towards 77.30. In contrast, investors are aggressively long dollars against the euro which means that at least initially a weak non-farm payrolls report will trigger a sharp rally in the EUR/USD. However as we have seen in past years, risk appetite can quickly take hold of the EUR/USD. This means that a weak number could end up being more positive for the dollar against the euro than negative but with traders already aggressively short the currency pair, the downside is probably limited. Although economists are looking for 55k job growth, we believe that the magic number is 100k. Job growth between 25k and 100k will be considered weak. Anything in excess of 100k and investors will start to question how quickly the Fed will implement QE3. Negative job growth on the other hand would be very bad for USD/JPY. 

In the meantime, the Non-farm payrolls report is a notoriously volatile piece of data 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 and the best currency pair to trade is generally USD/JPY because of its logical reaction to U.S. data. Even though the direction associated with each month’s move has not always been the same, the immediate reaction is typically not sustained, and frequently reverses into a more substantial move that lasts for the course of the trading day. The following chart shows how the EUR/USD responded after last month’s NFP report. There was very choppy trading in the EUR/USD the first hour after the release but after an initial V shaped move, the EUR/USD started to sell off aggressively into a move that lasted for the rest of the day. So when it comes to trading non-farm payrolls, it pays to wait for the volatility to settle and for the new trend to emerge before trading the EUR/USD.

EUR/USD 5 Minute Chart: Intraday move following payrolls report last month:

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Comments (1)

Darkdoji

October 06, 2011 at 01:46 PM ET

Very useful review.

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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.