August Non-Farm Payrolls Preview

Central banks and investors around the world are worried about the outlook for the U.S. economy. Whether these fears are accurate or misplaced will hinge on tomorrow’s non-farm payrolls report. The outcome of the NFP release is important because it will not only affect the market’s appetite for U.S. dollars but also the Federal Reserve’s decision about monetary stimulus. In Jackson Hole last month, Chairman Bernanke said the central bank stands ready to act if needed, which means that they are considering additional Quantitative Easing. If non-farm payrolls beat expectations, it would reduce the need for more QE but if the labor market report disappoints, it could force the Federal Reserve into action.

What are Market Expectations?  

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

Most Signs Point to Stronger Payrolls

Every month we attempt to predict the direction of non-farm payrolls by taking a look at a hearty list of labor market reports that are released before NFPs. This month, most of the leading indicators that we follow for non-farm payrolls points to stronger private sector payrolls growth in the month of August.  Every so often we are left without our most reliable indicator for payrolls, which is the service sector PMI report and unfortunately this is one of those months. Over the past 30 days, consumer confidence has improved, the manufacturing sector added jobs at its fastest pace ever while Challenger Grey & Christmas reported a 54.5 percent drop in job cuts in the month of August than brought total layoffs to the lowest level in more than decade. Although jobless claims have increased and the ADP report showed net job losses, the following chart indicates that ADP oftentimes undershoots private sector payrolls. In November 2009 and January 2010 for example, private sector payrolls increased even though ADP printed negative. However a stronger payrolls report is not the same as positive payrolls. Non-farm payrolls are simply expected to fall by a smaller amount while private sector payrolls are expected grow but in no way will these numbers be characteristic of a strong labor market report. 

Arguments for Better Non-Farm Payrolls:

1.      Challenger Reports Smaller but Still Sizeable Decline in Planned Layoffs

2.      Employment Component of Manufacturing Sector ISM hits Record High

3.      Continuing Claims Lower than Prior Month

4.      University of Michigan Consumer Confidence Increases

5.      Conference Board Consumer Confidence Increases

6.      10K Decline in Strike Activity

Arguments for Weaker Non-Farm Payrolls:

1.      ADP Reports Decline Private Sector Payroll Growth

2.      4-Week Average Claims Increases

3.      Census Job Reduction Could Account for as much as 110k jobs

ADP versus Private NFP

 

 

How to Currencies and Equities Could React to Payrolls

Since the government started to hire Census workers, foreign exchange traders have learned to look beneath the headlines because the change in private sector payrolls is more important than the net change in non-farm payrolls, which is distorted by temporary government hiring and firings. Therefore even though non-farm payrolls are expected to fall by 100k, traders are going into the payrolls report with a tinge of optimism as 42k private sector jobs are expected to be created in the month of August. However the range of forecasts by economists is wide which means that someone is bound to be surprised. Of the 77 economists surveyed by Bloomberg, 50 provided a private payrolls call. The most optimistic economist from ABN Amro predicts that private payrolls will rise by 120k while the most pessimistic from Standard Chartered expects the private sector to lose 17k jobs. As for the headline release, the forecast ranges from a high of 75k (Clearview Economics) to a low of -190k (4Cast Ltd). 

Of the -100k job losses forecasted for August, the majority will be in government jobs which is why the private sector payrolls report will receive just as much, if not more attention that the headline release which will provide the net change in non-farm payrolls. The Census jobs were meant to be temporary and the planned layoffs have already been discounted by the market. Investors could react to the payrolls report in many different ways but here are the 5 most likely scenarios:

Scenario 1: NFP Fall by 100k, Private Payrolls Grow 42k > No Major Reaction

Scenario 2: NFP Fall by Less than 80k, Private Payrolls Exceed 65k > Dollar Positive

Scenario 3: NFP Fall by Less than 80k, Private Payrolls Less than 30k > Mildly Dollar Negative

Scenario 4: NFP Fall by More than 100k, Private Payrolls Exceed 65k > Mildly Dollar Positive

Scenario 5: NFP Fall by More than 100k, Private Payrolls Less than 30k > Dollar Negative

Given the significance of the non-farm payrolls report, it will only be a quiet day in the forex market if both non-farm payrolls and the private sector payrolls report meet expectations to the T. However in all likelihood that would probably not be the case since the range of forecasts are so wide. Therefore the biggest shock would come from a positive non-farm payrolls report accompanied with strong additions in the private sector, which could trigger a sharp rally in the U.S. dollar. If overall job growth meets expectations but private sector job growth misses, the impact on the dollar will depend on the size of the disappointment. Private sector job growth of less than 30k would probably be very bearish for the U.S. dollar while job growth closer to 40k should only elicit a small reaction. Should the change in non-farm payrolls and private sector payrolls both disappoint, the impact on the dollar would be far more significant and would likely cause the greenback to sell off aggressively if the print is weak enough. If non-farm payrolls beat expectations but private sector payrolls fall short, the private sector number would undoubtedly overshadow the net change non-farm payrolls. 

As usual, USD/JPY will have the cleanest reaction to the non-farm payrolls report while high beta currency pairs such as the EUR/USD, GBP/USD and AUD/USD will respond to risk appetite. Be forewarned however as Non-farm payrolls are a notoriously volatile piece of data to trade as revisions and expectations can also impact the market's reaction.