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NFP Preview: Will Payrolls be Strong Enough to Extend the Rally?

Last updated 12/1/2011 10:29 AM ET (GMT -5) 1 Comments

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Kathy Lien

Director of Currency Research, GFT

Over the past month, we have seen a number of improvements in the U.S. economy yet Federal Reserve officials continue to talk of the need for more transparency and stimulus. This of course is related to their concerns about the European sovereign crisis and its impact on the financial markets but how quickly and aggressively they choose to change the guidance and language of their FOMC statement will partially hinge upon Friday’s non-farm payrolls report. There are many reasons to believe that the U.S. labor market continues to improve gradually despite the layoffs in the banking sector. In fact, nearly every single one of the leading indicators that we use to forecast the direction of payrolls points stronger job growth.

Private sector payroll provider ADP for example reported an increase of 206k jobs last month, a nice improvement from the 130k jobs added by U.S. companies in October. ADP has not been the perfect leading indicator for NFPs, but given the consistency of other labor market reports there is a good chance that the increase in job growth reported by ADP will carry through to NFPs. For the past 4 weeks, weekly jobless claims were at or below 400k and for this reason the four week moving average is also below 400k for the first time since April. Perhaps the improvement in consumer confidence can be explained by the improvement in the labor market. Both the University of Michigan and Conference Board reports increased in the month of November while Challenger Grey & Christmas reported a 13 percent decline in layoffs. The only indicator that pointed to slower job growth was the employment component of manufacturing ISM which fell from 53.5 to 51.8.

A good non-farm payrolls report will be a step towards recovery but Federal Reserve officials will continue to have their reservations until there is a credible solution to Europe’s debt crisis. Jobs have long been the missing ingredient in the U.S. recovery and for the time being, job growth has not been consistently strong enough to make a big dent into the unemployment rate. With Europe expected to remain in the midst of crisis in the New Year, the U.S. could still see slower growth which is why QE3 is not off the table. Nonetheless, a strong non-farm payrolls report will be something to celebrate, especially on the heels of the coordinated increase in liquidity provided by central banks this week

Leading Indicators for NFPs Point to Solid Job Growth

Here are the arguments for strong vs. weak NFPs.

Arguments for Better Non-Farm Payrolls:

1. ADP Reports Increase of 206k Private Sector Jobs

2. Challenger Reports 12.8% Drop in Layoffs

3. University of Michigan Consumer Sentiment Index at 5 Month High

4. Huge Jump in Consumer Confidence According to Conference Board Report

5. 4 Week Moving Average of Claims Below 400k, First Time since April

6. Continuing Claims Decline

Arguments for Weaker Non-Farm Payrolls:

1. Employment Component of Manufacturing ISM Declines Slightly

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

How to Trade Non-Farm Payrolls

The Non-farm payrolls report is a notoriously volatile piece of data to trade as revisions and expectations also impact the market’s reaction. The best currency pair to trade NFPs is generally USD/JPY because of its more logical reaction to U.S. data. The price action of other currency pairs is often diluted by their correlation to risk. If non-farm payrolls are strong, USD/JPY could finally muster the strength to close above 78. If it is weak, we expect the currency pair to make a run for 77.00. Considering how heavily skewed the leading indicators for non-farm payrolls are to a stronger report, job growth less than 100k would be a major disappointment for the market. Traders should remember that the knee jerk reaction in the EUR/USD to the non-farm payrolls is rarely the market’s true reaction and the one that lasts for the rest of the day.  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. The EUR/USD rallied the first five minutes after the NFP release, then quickly gave up all of its gains and traded down as much as 140 pips within the next 2 hours. 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)

moonie

December 01, 2011 at 12:15 PM ET

Very informative as usual. Thanks.

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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.