This Friday, we are expecting August Non-farm payrolls and now more than ever, the stability of the US economy hinges on the strength of the labor market. The amount of job growth last month will help the Federal Reserve decide between leaving the interest rate unchanged and cutting it by 25 or even 50bp. The recently weak economic data and sharp movements in the bond markets have boosted the risk of a recession, causing the US dollar to lose its luster as a safe haven currency. If job growth last month is less than 100k, then the risk of a recession becomes very real, but if it is greater than 100k, calm could be restored in the financial markets, at least for the time being.
With the vulnerability of the housing market has become increasingly apparent, US growth is at serious risk. Pending home sales, which is a leading indicator for home sales dropped 12 percent in the month of July. According to the Mortgage Bankers Association, foreclosures also rose to a record level in the second quarter as one out of every seven loans was delinquent. Adjustable rate mortgages are rising, putting a strain on homeowners as well as mortgage lenders who are faced with defaults. Investors with exposure to these loans have faced major losses of their own, resulting in bankruptcies, fund closures and an overall flight to safety. It has been argued by many Federal Reserve officials and Fed watchers that a rate cut may not be needed because the impact of the subprime and credit crisis on the real economy has been limited. However recent economic data has suggested otherwise and non-farm payrolls could really drive that point home. A sharp drop in job growth would mean that consumer spending could deteriorate materially since a sustained drop in spending is the main ingredient to a recession. That is why tomorrow?s NFP number is so important.
What US Dollar Traders Should Watch
Over the past few weeks, we have seen the dollar rally on weak US economic data as both domestic and international traders flocked to the safety of US treasuries. However the lack of a rally in the currency on Wednesday and Thursday despite weaker US economic data suggests that the economic outlook could be so uncertain that even international traders are looking to parking their money elsewhere while domestic traders move back into cash. A weak non-farm payrolls number would give them an even greater reason to invest in countries that are performing better, such as the UK and Australia. Right now the market consensus is for companies to add 100k jobs so a dollar bearish number would probably be anything below last month?s 92k rise. Job growth in excess of 125k on the other hand would be positive for the dollar. Of the 87 economists surveyed by Bloomberg, the most optimistic forecast is for 140k job growth while the most pessimistic is 35k. As usual, keep an eye out for revisions to the July figure because we have seen revisions to prior payroll numbers exacerbate or negate the surprise in the current month?s headline report. If both the headline and revised number turns out to be dollar negative, watch out because traders will pounce on the idea of sharply slower consumer spending and growth this quarter. Let?s take a look at what the market is expecting tomorrow:
What is the market expecting for August?
Change in Non-Farm Payrolls: 100k Forecast, 92k Previous
Unemployment Rate: 4.6% Forecast, 4.6% Previous
Change in Manufacturing Payrolls: -11k Forecast, -2k Previous
Average Hourly Earnings: 3.9% Forecast, 3.9% Previous
Average Weekly Hours: 33.8 Forecast, 33.8 Previous
The odds are strongly tilted in favor of a weaker NFP number:
Examining the Leading Indicators for Non-Farm Payrolls
Arguments for Below 100k Non-Farm Payrolls
[B]- ADP Employment Falls to 4 Year Low for 2nd Straight Month
- Challenger Reports a 21.7% Increase in Layoffs
- Employment Component of Service Sector ISM Drops to Contractionary Levels
- Hudson Employment Index Records Largest One-Month Slide
- Consumer Confidence Tumbles by Most Since 2005
- Help Wanted Ads Hit 49 Yr Low
- 4 Week Jobless Claims Rise to 326k from 307k in July[/B]
The laundry list of why non-farm payrolls could be weak tomorrow is endless. The employment component of the service sector ISM report dropped back into contractionary territory for the first time since September 2003 to match the lowest level seen since March of that year. At that time, payrolls increased by a mild 81k in September and dropped by 196k in March. The US subprime contagion took a toll on employment in the financial sector as job cuts surged to 35,752, the highest number among all industries surveyed. In addition to the disappointment in the ISM report, according to the ADP survey, private sector hiring slowed down to a four year low for the second consecutive month in August. Lay-offs announced by Challenger Gray and Christmas also rose to a six-month high of 79,459, up 21.7 percent on a year-on-year basis. Average jobless claims rose by 19k in August compared to the month of July. Not only are companies firing, but they are also not hiring as indicated by the help wanted ads, which have plummeted to 49 year lows. Turbulence in global financial markets and the persistence of a US housing slump eroded consumer confidence by the largest amount recorded since Hurricane Katrina in 2005; if the labor market was strong, confidence would not be this weak.
Arguments for Above 100k Non-Farm Payrolls
[B]- Employment Component of ISM Manufacturing Improves - Monster.com Employment Index Rose 3 Points
- Rebound in Public Sector Employment[/B]
Amidst a deluge of dour employment data, there are only a few arguments supporting labor market strength. The first is related to the manufacturing payrolls report. Unlike the employment component of service sector ISM, manufacturing ISM reported an increase in employment which should help to limit further job losses in the manufacturing sector. On the service side of things, the only factors supporting stronger job growth is the rise in job advertisements posted on Monster.com and the potential for a rebound in public sector employment. According to the online recruiting firm, their Employment index increased three points, but despite the rise, the overall increase in job growth is still modest compared to previous years and “points to further moderation in online recruitment activity compared to last year.” Meanwhile the public sector shed 28k jobs last month, the biggest drop in 1.5 years. A rebound could help to offset private sector job losses.
Conclusion
Typically when the leading indicators for non-farm payrolls is overwhelmingly in support of either a stronger or weaker number, the BIG surprise or potentially larger market mover would be if the opposite happens. In the case of August however, we do not believe that this is true. Most of the data points to a horrid NFP number. If the number turns out stronger, even though the dollar could rise, the rebound may still be limited because in the grand scheme of things, the US economy is vulnerable and traders will believe that even if we do not see weak job growth in August, we will see it in September. If NFP is weak however, the remaining people who may have not been convinced that the Federal Reserve will lower interest rates on September 18 will have to join the majority and adjust their positions accordingly, which could lead to a big move in the US dollar.
Written by Kathy Lien, Chief Currency Strategist of DailyFX.com