January Non-Farm Payrolls Preview: Where are the Risks?

Non-farm payrolls are due for release on Friday and economists are looking for the U.S. economy to return to positive job growth. If they are right, this would be the second month out of the three that more jobs were added than lost after the recession since revisions last month revealed that 4k jobs were created in November. A small uptick in jobs would indicate that the labor market is slowing improving much like a semi making a wide turn on a highway. It will eventually round the corner, but it will be a slow, gradual and messy process. Also, this morning's jobless claims report dashed hope for healthy improvement in payrolls. First time jobless claims rose from 472k to 480k, matching the highest level since mid-December. All signs point to an improvement in the labor market but after shedding 85k jobs last month, smaller jobs losses would still represent an improvement. The more important question is whether job growth in January was the strongest in more than 2 years. The consensus forecast is currently favoring a 15k rise in non-farm payrolls but with estimates ranging from up 100k to down 100k, no one really knows. For forex traders, this means that there could be an unusual amount of volatility in the dollar following the payrolls report on Friday.

7 out of 10 Leading Indicators for Non-Farm Payrolls Point to an Improvement in Labor Market

Every month we look at 10 leading indicators for non-farm payrolls and for the most part, all of them indicate that the labor market has improved. The fall in continuing claims, the moderation of private sector job losses (ADP), the rise in the employment component of manufacturing ISM and improvement in consumer confidence provides the most convincing arguments for positive job growth. However the tepid rise in the employment component of non-manufacturing (service sector) ISM, which tends to have the strongest correlation with non-farm payrolls makes us a bit weary of the market's call for positive job growth. The employment component remains in contractionary levels which mean that on balance, companies in the service sector are still cutting jobs. With companies like Verizon announcing 13,000 new layoffs at the end of January and Pharma planning to eliminate 8,170 jobs, most U.S. businesses are still not at the point where they are ready to hire. Here are the arguments for a stronger versus weaker non-farm payrolls report:

Arguments for Better Non-Farm Payrolls:

1. Employment Component of Service Sector ISM Rises to 44.6 from 43.6

2. Continuing Claims at 4.602M compared to 4.807M at end of Dec

3. Employment Component of Manufacturing Sector ISM Reaches Highest Since Sept 2008

4. ADP Reports Smallest Private Sector Job Losses in Two Years

5. Conference Board Consumer Confidence at Highest Level in More than a Year

6. University of Michigan Consumer Confidence Increases for Second Month

7. Zero Strike Activity

Arguments for Weaker Non-Farm Payrolls:

1. Jobless Claims 4 Week Average at 468k Compared to 460k at End of Dec

2. Challenger Layoffs Rise Off of Two-Year Low

3. Monster.com Employment Index Falls 1 Point in January

Job Growth can occur even if the Employment Component of Service Sector ISM contracts

Yet it is important to also note that job growth can occur even if the employment component of service sector ISM contracts. The following chart indicates that over the past decade, there have been 4 months where non-farm payrolls increased even though the employment component of the service sector ISM report indicated that companies continue to reduce their workforce.

What are the Risks for the Dollar?

Risk # 1 - Payrolls Fall Short of Expectations

Given these arguments, the biggest risk for the non-farm payrolls report would be a miss. The forecast is high and although there are many reasons to believe that the U.S. labor market improved, the arguments for positive job growth are not as convincing. If payrolls fall short of expectations, we could see a sharp sell-off in the U.S. dollar against the Japanese Yen.

Risk # 2 - Big Downward Birth / Death Model Revisions to NFP

However revisions due to the birth death model could also affect how traders react to the NFP report. Every February, the Bureau of Labor Statistics revises past NFP numbers and this year, the revisions could eliminate as much as 842k jobs from the April 2008 to March 2009 payroll reports. This would suggest that labor market was in worse shape during the recession than what the BLS originally reported because of layoffs tied to business closings. The following is a graphic created by Bloomberg that illustrates their expected revisions to NFPs. The dark blue bars are the job losses that were announced and the light blue extensions are the revisions that are expected. A big revision to past non-farm payrolls reports could temper a positive reaction in the dollar to the NFP release or exacerbate a negative reaction.

Source: Bloomberg

Risk # 3 - Upward Revision to December Payrolls Report

The third risk for the dollar would be an upward revision to last month's non-farm payrolls number. Job losses were steep in December and at odds with many of the other labor market reports released that month. Therefore we would not rule out a sharp upward revision to job losses reported in last month which could also temper the dollar's positive reaction to an in line, stronger or even slightly weaker January NFP report or exacerbate a bearish reaction to a weak number.

Bottom line - Uneven Improvement in the Labor Market

The bottom line however is that after such a deep recession, the improvement in the labor will be uneven. After the recession in the early 2000s and in the 1990s, the U.S. economy returned to positive job growth only to revert back to net job losses shortly thereafter and to a less degree, this also happened in the 1980s.

What are the Expectations?

Here are the forecasts for January Non-Farm Payrolls:

To reiterate, any job growth with no major downward revisions to prior data should be initially positive for the dollar while continued job losses would be bearish for the dollar. 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 because when the equity market opens, risk flows can affect the dollar. Therefore when it comes to trading NFPs, it usually pays to wait.

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