September Non-Farm Payrolls: Will it Save the US Dollar?

This Friday, we are expecting Non-farm payrolls for the month of September and now more than ever, the fate of the US dollar and stability of the US economy hinges upon the outcome of tomorrow?s labor market report. On September 18th, the Federal Reserve cut interest rates for the first time in 4 years. Although concern about the credit market played a major role in the decision, the central bank also found the first drop in payrolls since September 2003 alarming. At the time, the market was looking for a 100k rise, which is the same forecast for tomorrow, but instead of adding 100k jobs, US companies actually laid off 4k workers. The market is currently divided on whether the Fed will continue to lower interest rates later this month and tomorrow?s non-farm payrolls report will help to confirm or deny that.

Since the beginning of the week, the US dollar has been quietly recovering on the expectation that payrolls will be firm. If job growth was indeed greater than 100k, then we expect the dollar to recover further. However should job growth rise by less than 70k, we could see the dollar fall back to its record lows. (Also See How To Trade NFP)
Since the last interest rate cut, the stock market has rallied as much as 800 points, credit default swaps and the 10 year Junk bond to Treasury Spread are both off their highs, while the US dollar is significantly lower (see our report on Watch What the Fed Watches for more details). Overall, the markets are calmer now than they were 3 weeks ago, reducing the need for the Federal Reserve to act as aggressively as the market may have initially wanted. The housing market is still trouble with existing, new and pending home sales all continuing to fall, but we have had no new blowups of hedge funds or subprime lenders. The leading banks on Wall Street have all reported sharp losses as a result of exposure to the subprime market, but it seems that traders are optimistic that the write downs have put the worst behind us which is why they are only pricing in a 68 percent chance of an October rate cut and a less than 50 percent chance of a cut in December. Tomorrow?s non-farm payrolls number will help to determine if at least for the time being, the worst is really behind us because a recovery in job growth means that consumer spending may hold steady, reducing the risk of the US economy falling into a recession.
[B]What Should Traders Watch For[/B]
Last month, seven indicators correctly forecasted a weak payrolls number. This month, four out of those seven including the ADP survey and the Challenger layoffs report signal that there will be a sharp improvement in payrolls. Despite the retracement in the US dollar today after the ECB and BoE interest rate decisions, the dollar is still stronger on the week because economic data does support positive payroll growth. The only question is will payroll growth be strong enough to meet the market?s lofty expectations. The current forecast is for companies to add 100k jobs. Of the 83 economists surveyed by Bloomberg, the most optimistic forecast is by Bear Stearns who expects 175k jobs while the most pessimistic is National Bank Financial, who expects only 15k job growth. As you can see, no one expects two consecutive months of job losses. Given the strength of the NFP leading indicators, we also do not think that job growth was negative in September. If job growth is less 70k the US dollar will probably fall, but anything in excess of that should be dollar positive. The revision to the August number will also be extremely important and we would be surprised if there are no revisions. As usual, the revised number could easily exacerbate or negate the changes to the current month?s headline number.
Let?s take a look at what the market is expecting tomorrow:
[B]What is the market expecting for September?[/B]
[B]Change in Non-Farm Payrolls:[/B] 100k Forecast, -4k Previous
[B]Unemployment Rate:[/B] 4.7% Forecast, 4.6% Previous
[B]Change in Manufacturing Payrolls:[/B] -10k Forecast, -46k Previous
[B]Average Hourly Earnings:[/B] 3.9% Forecast, 3.9% Previous
[B]Average Weekly Hours:[/B] 33.8 Forecast, 33.8 Previous
The odds are tilted in favor of a stronger NFP number, but there are solid arguments supporting both stronger and weaker job growth:
[B]Examining the Leading Indicators for Non-Farm Payrolls[/B]
[B]Arguments for Stronger Non-Farm Payrolls Growth[/B]
[B]- ADP Employment Indicates Increase of 58K in Private Payrolls

  • Challenger Reports a 28.5% Decrease in Layoffs
  • Employment Component of ISM Non-Manufacturing Rose to 3-Month High
  • 4 Week Average of Jobless Claims Drop from 324k to 311k[/B]

There are many reasons why non-farm payrolls could be strong tomorrow. After dipping into contractionary territory for the first time since September 2003, the employment component of the ISM report jumped back into expansionary territory, signaling that the service sector added more jobs than it lost last month. The ADP employment survey also rebounded after hitting a 4 year low in August. The private sector is expected to contribute at least 58k jobs to payrolls. Even though jobless claims were weaker for the week ending September 29, the latest release is not a survey week which means that it does not impact on tomorrow?s non-farm payrolls report. The four week moving average of claims has dropped from 324k in August to 311k in September. Challenger Gray and Christmas also reported a 28.5 percent decrease in layoffs, negating last month?s 21.7 percent rise. All four of these reports accurately predicted a weak payrolls report last month. If the labor market does stabilize, we could see a wave of optimism sweep across the financial markets.
[B]Arguments for Weaker Non-Farm Payrolls Growth[/B]
[B]- Hudson Employment Index Drops by 2.1 Points

  • Employment Index of Job Advertisements Did Not Change
  • Help Wanted Ads Hit All-Time Low
  • Consumer Confidence Hovers Near 2-Year Lows[/B]
    Just as there are four reasons supporting strong payroll growth, there are also four reasons supporting weaker growth. The Hudson Employment Index recorded its largest one month slide in the month of August and instead of stabilizing, it has declined further in September. The percentage of workers expecting their employer to increase hiring fell to 28 percent, the lowest since the first survey in December 2003. Further confirmation of the slowdown in hiring came as the Conference Board?s gauge of help-wanted ads plunged to a fresh all-time low of 23. Uncertainty over employment prospects took a toll on consumer confidence, and the index for sentiment through the week of September 18 deteriorated beyond expectations to the weakest level in nearly two years. The percentage of respondents who considered jobs to be “plentiful” declined to 25.7 percent from 27.5 percent while individuals who found jobs “hard to get” rose to 22.1 percent from 19.7 percent. After rising 3 points last month, the Employment index remained unchanged. According to the press release, opportunities for white-collar occupations in general and the financial sector in particular have eased. Not a day has gone that we have not heard a fresh lay off announcement in the financial sector over the past few weeks. This has driven consumer confidence to a 2 year low. If the labor market is really recovering, confidence would not be this weak.
    As you can see, there are strong arguments in favor of both strong and weak payroll growth. Overall we do not expect another month of job losses, but at the same time there is a strong chance that payrolls could fall short of expectations. The currency market is banking on a strong release and the recent correction in the stock market indicates that equity traders expect one as well. Even the recent movement in bonds suggests that the same sentiment is shared by fixed income traders. Compared to the moves that we have seen since the beginning of September, the latest retracements or corrections are comparably mild, indicating that many traders are only cautiously optimistic. Therefore we expect a big reaction to tomorrow?s non-farm payrolls number regardless of whether it is strong or weak because traders will be looking to the headline number and the revision for clarity on what the Federal Reserve will do at the end of the month.

[B]Written by Kathy Lien, Chief Strategist[B] for[/B][/B]