The Federal Reserve cut interest rates by 25bp yesterday and hinted that they will pause when they meet again in June. In response to this shift, the market immediately priced in an 85 percent chance that interest rates will be left at 2 percent at the next two monetary policy meetings. Since then the expectations have eased slightly as traders gear up for Friday’s non-farm payrolls report. The sell-off in the US dollar following the FOMC rate decision suggests that many market participants are not necessarily convinced by the hawkish comments from the Federal Reserve. If the labor market continues to weaken, the central bank may have no choice but to pick up where they left off and only hope that slower US demand will be enough to bring down inflation. The level of non-farm payrolls in the month of April will help to determine whether the Federal Reserve will really keep interest rates unchanged in both June and August and where the US dollar is headed next.
Could Non-Farm Payrolls Drop by 100k?
Nearly everyone in the market seems to agree that non-farm payrolls will fall for the fourth month in a row, but will the job losses be more severe than what has been reported over the past 3 months? Job growth has been a sore point for the US economy for sometime and in March, the labor market reported its worst performance since March 2003. Analysts are currently looking for a mild improvement, but we believe that the conditions in the US labor market will worsen. In fact, non-farm payrolls could have even drop by 100k last month given the level of layoff announcements that have been announced. Here is a sampling of the most notable ones and although these jobs are expected to be cut over the course of the next few months, they certainly do not paint a pretty picture for the labor market.
Layoff Tally
-3500 GM 4.30.08
-1100 United Air 4.22.08
-9000 Citigroup 4.18.08
-4000 Merrill Lynch 4.17.08
-4000 AT&T 4.17.08
-730 Harley 4.17.08
-1600 AMD 4.17.08
-4000 Aloha Airlines and ATA 4.07.08
-1000 Home Depot 4.05.08
-2600 Motorola 4.04.08
-8800 Dell 4.04.08
-5500 Schering-Plough 4.03.08
Most people including Warren Buffett already believe that the US economy is in a recession and during recessions the labor market usually deteriorates. Over the past 3 decades, the US economy has gone through 3 recessions. In each of those 3 recessions, there was a string of job losses that lasted for a minimum of 10 months. Many people argue that the current downturn in growth could be more severe than the recession in the early 2000s due to the triple blow of a housing crisis, credit crunch and skyrocketing commodity prices. If this is true, we will see far more than 4 consecutive months of job losses. In each of the past 3 recessions, the largest single month job loss was more than 300l. In this context, a 100k drop during the month or April or May is not only realistic but guaranteed.
The following chart illustrates the strong correlation between the employment component of service sector ISM and non-farm payrolls. The last time, the employment component (blue line) was at current levels, job losses were double the drop in February. The drop in March does not get us even near the levels that the charts suggest which means that job losses could have worsened last month. If NFPs rebound, we would only consider it a recovery before a more serious deterioration in the US labor market.
ADP Could Overestimates Non-Farm Payrolls
The primary argument for a rebound in payrolls continues to be the jump in the ADP employment report. However given that ADP has overestimated payrolls growth for the last 6 months, the accuracy of their report, particularly the positive print remains questionable. In March, ADP also reported an increase in private sector growth, but private sector non-farm payrolls actually dropped close to 100k.
What is the market expecting for April Non-Farm Payrolls?
Change in Non-Farm Payrolls: -75k Forecast, -80k Previous
Unemployment Rate: 5.2% Forecast, 5.1% Previous
Change in Manufacturing Payrolls: -35k Forecast, -48k Previous
Average Hourly Earnings: 3.6% Forecast, 3.6% Previous
Average Weekly Hours: 33.7 Forecast, 33.8 Previous
Of the 82 economists polled by Bloomberg, the most optimistic forecast is by National City Corporation who calls for drop of 18k jobs. The most pessimistic is ING Financial who is calling for job loss of -150k. Most economists expect a negative print, but the range of estimates is extremely wide which means that traders should expect sharp volatility in the US dollar and the financial markets in general on the back of the non-farm payrolls release.
In order to determine the strength of non-farm payrolls, we typically look at 10 pieces of data that we call the leading indicators for non-farm payrolls. However, since ISM Services will not be released until next week, we will only utilize 9 figures. Six out of the ten releases point to greater job losses, and of the three that signal an improvement, one still indicates that labor market conditions are weakening. More specifically, planned layoffs are surging, the University of Michigan consumer confidence survey plunged to a 26-year low while the Conference Board’s measure hit a 5 year low. Continuing jobless claims are also on the rise, and strike activity cut 3,600 jobs from US payrolls. On the other side of the spectrum, we had much better-than-expect ADP and Monster.com Online Ad readings. The 4-week moving average of jobless claim fell back slightly, but the figure is still near the October 2005 highs as the more volatile weekly reading jumped to 380k from 345k.
It is worth noting that the one indicator we are missing – the employment component of service sector ISM – is usually a very reliable leading indicator for NFPs, which only adds to the uncertainty surrounding this particular report. In fact, the ADP report showed that the services sector was the only area to take on workers, as those involved in the manufacturing and goods-producing sectors posted net job losses. Furthermore, Jesse Harriott, Vice President of Research at Monster Worldwide Inc., said that the gain in the Monster.com Employment Index was “largely seasonal in nature,” which is a typical characteristic of service-related jobs. As a result, there is a possibility that a jump in hiring in the services sector could help balance out losses in manufacturing, which would be the only reason why job losses could be less than the prior month.
Arguments for Weaker Non-Farm Payrolls
1. Challenger Report Showed a 27.4% Increase in Planned Layoffs
2. Continuing Claims: 4 Week Moving Average on the Rise
3. Consumer Confidence Hits Multi-Year Lows
4. Strike Activity Still Up at 3,600
5. Help Wanted Ads Drop to Yet Another Record Low
6. Employment Component of Manufacturing ISM Drops Lower
1. Jobless Claims 4 Week Moving Average Eases, Still Near the October 2005 Highs
2. ADP Employment Report Increases 10k vs. Expectations of -60k
3. Monster.com Online Ads Posted Biggest Single Month Increase in Over a Year
Will April Non-Farm Payrolls be Better or Worse than March?
The majority of the leading indicators for non-farm payrolls indicate that April was a month of job losses. However, even though the odds are skewed towards greater job loss and we favor a month of -100k payrolls, conflicting reports make it important not to rule out the possibility there was less jobs lost in April than there was in March. Either way, given lackluster business conditions, weakening domestic demand, and poor outlooks for the financial sector in particular, the state of the labor market will grow increasingly worse in the coming months even if there is a rebound in April.
What Does this Mean for the US Dollar?
For traders, if non-farm payrolls are worse than expected, the US dollar could erase some of its recent gains. However don’t forget that the Fed has the benefit of seeing two NFP reports – April and May before their next rate decision which means that market’s reaction to a bad number may be tempered. From a sentiment and technical perspective, the dollar should continue to rally.
Our FXCM Speculative Sentiment Index flipped for the first time since 2006. As a contrarian indicator, the flip suggests that we could see a further weakness in the EUR/USD over the next few weeks.
From a technical basis, our analyst Jamie Saettele indicated that if you follow our Daily Technical report, then you have been on top of the EURUSD decline in recent days. Here is a review and what to expect as event risk will likely lead to increased volatility. The decline since 1.6018 is unfolding as an unmistakable impulse. 5 waves down from 1.6018 to 1.5554 was the indication that the larger trend had changed from up to down. A 3 wave setback in wave 2 confirmed our bearish bias (notice that wave 2 ended right at the 4th wave of one less degree…which is common). Wave 3 is underway now. 3rd waves are the ‘meat’ of the trend; the big move that every trader wants to catch. Interestingly, 3rd waves bring added volatility, which fits perfectly with the NFP release tomorrow morning. Going forward, remain aggressively bearish against 1.5643 (red line). Resistance for tonight and tomorrow morning should be strong in the 1.5500/1.5540 zone (black lines). Measured support does not begin until 1.5230 (100% extension of 1.6018-1.5554/1.5694). Subjectively, we favor a deeper decline to at least the 161.8% extension, at 1.4943, in the coming weeks.
If non-farm payrolls are better than -75k, this should support the signal given by technical and sentiment as the dollar would rally and rate cut expectations will grow in favor of no change in policy when the Federal Reserve meets again in June. As usual, also watch for revisions to the March figure because it can easily exacerbate or negate the changes to the current month’s headline number.