For currency traders, the US Non-Farm Payrolls (NFP) release is an event that typically promises high volatility and can even signal the beginning for a new trend when the dollar is listless. Considering the volatile mix of current market conditions, the intensified focus on the pace of economic recovery and the congestion patterns the majors have been relegated to for the past three months; the stars seem to be aligning for this single event to catalyze a new phase for the currency.
However, the impact and reaction may not be so straightforward. Thin liquidity has contributed to the market’s inability to develop a trend; and the long US holiday weekend coming up will further dampen activity. Then again, shallow markets further exacerbate price swings and could more readily produce the long-awaited breakout. Let’s look into the factors that will determine whether the labor data can usher in a new trend or simply be ignored as the weekend nears.
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Taking Measure of Forecasts
Regardless of the exogenous, market dynamics surrounding the economic release; the data could fall flat if the data is in line with what market participants are pricing in and economists are forecasting. It is difficult to gauge the consensus from speculators as they use their predictions to position themselves. Therefore, price action in the lead up to the event is the most accurate barometer for sentiment. However, traders also base their projections on the official consensus. That is far easier to benchmark.
According to Bloomberg’s poll, the US economy likely lost a net 230,000 jobs through August. This would be the smallest contraction in a year; but not a significant improvement in pace from July. Decidedly less bullish is the expected uptick in the unemployment rate. The market was dealt a shock last month when Bureau of Labor Statistics reported an unexpected improvement in the jobless rate from its 26-year high 9.5 percent to 9.4 percent. This also happened to be the first improvement in this series since April of 2008. As one of the most lagging indicators for economic activity, this indicator clearly held significant meaning. Looking at the breakdown of analyst expectations, the forecast spread is relatively narrow (with a high of -100K and low of -365K) and evenly spread for those above and below the consensus. The rate on the other hand shows significant divergence. Altogether, the net change can easily induce surprise by a significant deviation and the percentage of unemployed can have a meaningful impact in all three scenarios (better, worse or in line with expectations).
What the Data Says
We are not heading into this event blind. Far from it. The popularity of this economic report has encouraged a number of secondary and ancillary labor statistics into the foreground. Over the past week, the data has been broadly positive.
Arguments for an Improvement in Non-Farm Payrolls
- Conference Board’s Consumer Confidence survey labor differential improves from -44.8 to -40.9. Those seeing jobs becoming more plentiful in the coming six months rose from 15.5 percent to 18.4 percent.
- The ISM Manufacturing employment gauge rose to a one year high of 46.4 from 45.6.
- The ISM Non-Manufacturing (service sector) employment gauge rose to an 11-month high of 43.5 from 41.5.
- ADP Private Payrolls contract by 298,000 – the smallest in 11 months.
- Challenger Job Cuts drop 13.8 percent – the most in 11 months.
Arguments for a Deterioration in Non-Farm Payrolls
- Initial Jobless Claims through August 29th shrank less than expected to 570,000. The four-week average continues to rise from its yearly low.
- Though Continuing Jobless Claims rose in the week through August 22nd, the four-week average fell to its lowest level since April 4th.
The Fundamental Impact
Looking beyond the surprise quotient and market reaction, there is much more to take away from the August employment data. Consumer spending is the largest source of growth for the world’s largest economy and it is also a relatively objective measure. Consequently, these statistics offer the most reliable timely barometer for economic activity. Putting this month’s data into context, we have seen a steady improvement in the pace of job losses for the past six months; yet the unemployment rate has not confirmed a top. This proffers the same general sentiment that the broader outlook for growth has been saddled with: early signs of a recovery.
While risk trends continue to hold their dominance over volatility and trend in the markets, the potential for growth and returns is a prominent theme that is growing in influence. This is particularly true for currencies. Since a currency’s value is found largely through the strength of the economy that backs it as well as the benchmark yield; the recovery in the US (along with the shift in its monetary policy) is pitted against that of its industrialized peers. With the Euro Zone’s two largest economies already posting positive growth through the second quarter, the burden is on the US to catch up.
The Real Reaction
Fundamental context is certainly important when absorbing one of the most market moving indicators into your analysis; but as we have discussed, that does not necessarily translate into meaningful price action. There are two immediate concerns for gauging the market’s initial response to this event risk – surprise and background conditions. If the actual numbers do not deviate from what the market at large was already pricing in, then the dollar will already be fairly valued. On the other hand, a break from the consensus (depending on its severity) could leverage thin liquidity for an extraordinarily volatile response. At the same time, a lack of market depth could either lead to a fast moving trend or it may even snuff a rally out. Looking ahead to the long holiday weekend, without a considerable surprise from this data; it is more likely that range boundaries will hold and the dollar will have to have to wait for a new trend until a later date. Then again, the more fundamental pressure that builds behind the market, the more likely it is that a speculative breakout could support itself in a new trend.
Written by: John Kicklighter, Currency Strategist for DailyFX.com
Questions? Comments? Send them to John at <[email protected]>.