Given Federal Reserve Chairman Ben Bernanke’s comments earlier this week, it is clear that the FOMC is done cutting rates for the time being. Indeed, we saw the US dollar rally on Tuesday as Mr. Bernanke said that “policy seems well positioned to promote moderate growth and price stability over time.” While another month of contraction in non-farm payrolls would not really increase the chances that the Fed will cut rates again in June, the report is still the most market moving indicator for the US dollar, so traders should certainly watch the release on Friday morning as it could exacerbate or put an end to the EUR/USD surge seen on Thursday.
Given Federal Reserve Chairman Ben Bernanke’s comments earlier this week, it is clear that the FOMC is done cutting rates for the time being. Indeed, we saw the US dollar rally on Tuesday as Mr. Bernanke said that “policy seems well positioned to promote moderate growth and price stability over time.” While another month of contraction in non-farm payrolls would not really increase the chances that the Fed will cut rates again in June, the report is still the most market moving indicator for the US dollar, so traders should certainly watch the release on Friday morning as it could exacerbate or put an end to the EUR/USD surge seen on Thursday.
[B]Could Non-Farm Payrolls Drop by 100k?
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The US non-farm payrolls report is one of the most critical releases for the US dollar, not only because it is market-moving, but also because it can help us gauge the broad status of the economy. Despite the fact that Q1 GDP was revised up to 0.9 percent from 0.6 percent just last week, it is far too early to say that the US economy has successfully avoided a recession. A “recession” does not necessarily mean that GDP falls negative, as the National Bureau of Economic Research (NBER) defines it as “a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales.” It could easily be argued that the slump in US GDP from 4.9 percent during Q3 2007 down to 0.6 percent in Q4 2007 and 0.9 percent in Q1 2008 represents a “significant decline.”
Over the past 3 decades, the US economy has gone through 3 recessions, according to NBER. In each of those 3 recessions, there was a string of job losses that lasted for a minimum of 10 months. Thus far, non-farm payrolls have fallen negative for the past 4 months, and the May report is anticipated to bring this tally up to 5. Some 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. As if this weren’t enough, the odds are in favor of more severe job losses in coming months because in each of the past 3 recessions, the largest single month job loss was more than 300k! In this context, a 100k drop over the next few months is not only possible, but probable.
The following chart illustrates the strong correlation between the employment component of service sector ISM and non-farm payrolls. For the most part, we’ve consistently seen that when this component (blue line) falls below 50 – signaling contraction – non-farm payrolls have fallen negative. Given the drop in the component to 48.7 from 50.8 during the month of May, there is a very good chance that non-farm payrolls will, at the very least, fall in line with expectations.
[B]What is the Market Expecting for May Non-Farm Payrolls?
Change in Non-Farm Payrolls:[/B] -60k Forecast, -20k Previous
Unemployment Rate: 5.1% Forecast, 5.0% Previous
Change in Manufacturing Payrolls: -40k Forecast, -46k Previous
Average Hourly Earnings: 3.4% Forecast, 3.4% Previous
Average Weekly Hours: 33.7 Forecast, 33.7 Previous
Of the 79 economists polled by Bloomberg, the most optimistic forecasts are by BNP Paribas, Credit Suisse, and Dekabank, all of which call for a drop of 10k jobs. The most pessimistic is, once again, ING Financial Markets 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. Eight out of the ten releases point to greater job losses, putting the odds greatly in favor of a weak non-farm payrolls reading in line with expectations. More specifically, planned layoffs are surging, the University of Michigan consumer confidence survey plunged to a 28-year low while the Conference Board’s measure hit a nearly 16 year low. Continuing jobless claims are also on the rise, and strike activity cut 8,300 jobs from US payrolls. On the other side of the spectrum, we had much better-than-expect ADP and Initial Jobless Claim readings. However, while the 4-week moving average of jobless claim fell back slightly, the figure is still near the October 2005 highs.
Arguments for Weaker Non-Farm Payrolls
[ol]
[li]Services ISM Employment Component Falls Below 50 [/li][li]Consumer Confidence Indexes Hit 16 and 28-Year Lows [/li][li]ISM Manufacturing Employment Component Holds Below 50 For 7th Consecutive Month [/li][li]Challenger Reports Shows Planned Layoffs Surge 45.6% [/li][li]Help Wanted Index Holds at Record Low of 19.0 [/li][li]Work Stoppages Increase as 8.3K Workers Go On Strike [/li][li]Monster.com Online Ads Decline For First Time In 4 Months [/li][li]Continuing Claims: 4 Week Moving Average on the Rise[/li]
[/ol] Arguments for Stronger Non-Farm Payrolls
[ol]
[li]ADP Employment Report Jumps 40K vs. Expectations of -30K [/li][li]Initial Jobless Claims 4-Week Moving Average Slips For Second Consecutive Week[/li] [/ol] Will May Non-Farm Payrolls be Better or Worse than April?
The majority of the leading indicators for non-farm payrolls indicate that May was a month of job losses. However, this reading depends very much on conditions in the services sector as conflicting reports make it important not to rule out the possibility there were less jobs lost in May than there were in April. While the employment component of ISM services tumbled below 50 – signaling contraction – the surprise gain in the ADP employment index was due primarily to a jump in hiring in the services sector. Either way, given lackluster business conditions, weakening domestic demand, and poor outlooks for the financial sector in particular, the state of the labor market is very likely to grow increasingly worse in the coming months.
How Will the US Dollar Respond?
The US dollar has spent much of the early days of June gaining on speculation that the US economy is in the clear and the Fed is done cutting rates. However, the currency tumbled versus the euro on Thursday thanks to hawkish commentary by European Central Bank President Trichet, who raised the prospect of a rate hike by the ECB in July. According to Technical Strategist Jamie Saettele’s Elliott Wave Analysis from Thursday morning, there may be additional downside potential for the greenback. Indeed, Jamie notes that the decline from 1.5817 is labeled as a W-X-Y (complex) correction, and that the minimum bullish objective is one pip above 1.5817. Furthermore, he says that even if a larger more complex correction is unfolding from 1.6018 (such as a flat or a triangle), price is still expected to exceed 1.5817. As a result, if the non-farm payrolls figure is released in line with expectations and declines by approximately 60,000 or more, EUR/USD will likely break above near-term resistance at 1.5600 and continue its ascent. On the other hand, better-than-expected non-farm payrolls could cap the pair’s gains on Friday, though it may only be a matter of time before the US dollar starts to weaken again.
[B]Written by Terri Belkas, Currency Analyst for DailyFX.com
Questions? Comments? Email: [/B][email protected]