Currency Markets Look to Non-Farm Payrolls to Determine US Recession Risks
The possibility of a US recession in 2008 is one of the biggest debates in the financial markets and tomorrow’s non-farm payrolls report will be critical in determining whether a recession is not only possible, but probable.
The possibility of a US recession in 2008 is one of the biggest debates in the financial markets and tomorrow’s non-farm payrolls report will be critical in determining whether a recession is not only possible, but probable. Market expectations have shifted significantly based upon incoming economic data. On December 31st, stronger existing home sales led futures traders to believe that the Federal Reserve only needs to lower interest rates by 25bp at the end of January. However these expectations shifted significantly on Wednesday after manufacturing ISM fell into contractionary levels in December. The futures market went from pricing in the odds for a 25bp vs. 0bp rate cut to 25bp vs. 50bp. As much as ISM has been able to shift the market’s expectations for interest rates, the impact that non-farm payrolls will be even more dramatic because a weak labor market compounds the odds for a recession.
What Should Traders Watch For
In November, non-farm payrolls increased by 94k, which was stronger than the market expected but not good enough to stop the dollar from falling the following Monday and Tuesday. Of the 10 leading indicators for non-farm payrolls that we typically follow, 9 forecasted job growth to be weaker than the month of October, and only the ADP employment report projected a strong released. Now, 6 of the 10 indicators forecast weak job growth, including the ADP report and ISM Manufacturing. Usually, the ISM Services report is released prior to non-farm payrolls and is one of the indicators we typically use. However, this month it will hit the wires after non-farm payrolls so instead, we’ve added Continuing Claims to the list. This figure actually rose for the fourth consecutive week to two-year high of 2761k, suggesting that more and more people are having difficulty finding work and are becoming reliant on unemployment benefits. Of the 72 economists surveyed by Bloomberg, the most optimistic forecast is by Desjardins Group who expects an addition of 106k jobs while the most pessimistic is by National City Bank, who expects an increase of only 22k jobs. We expect the dollar to rally if payroll growth is stronger than 90k, but if it is less than 65k, dollar weakness will continue.
The following charts compare the monthly releases of ADP with private sector payrolls and total non-farm payrolls. Generally speaking, the two releases are correlated, but as with everything, the correlation is not perfect. Last month was the perfect example when ADP reported private sector payroll growth of 189k. Actual private sector growth according to the non-farm payrolls report was only 64k. Therefore even though ADP reported 40k payroll growth in the month of December, we cannot rely on it exclusively.
Let’s take a look at what the market is expecting tomorrow:
What is the market expecting for December?
Change in Non-Farm Payrolls: 70k Forecast, 94k Previous
Unemployment Rate: 4.8% Forecast, 4.7% Previous
Change in Manufacturing Payrolls: -15k Forecast, -11k Previous
Average Hourly Earnings: 3.6% Forecast, 3.8% Previous
Average Weekly Hours: 33.8 Forecast, 33.8 Previous
The odds are tilted greatly in favor of a weaker NFP number, but we cannot ignore the improvements in consumer confidence and the decline in Jobless Claims.
Examining the Leading Indicators for Non-Farm Payrolls
Arguments for Stronger Non-Farm Payrolls Growth
1. Consumer Confidence Rebounds Unexpectedly after Dropping to 2 Year Lows
2. 4 Week Average of Jobless Claims Falls Back to 343.75K
3. Challenger Reports a 18.7% Drop in Layoffs From The Year Prior
Arguments for Weaker Non-Farm Payrolls Growth
1. Employment Component of Manufacturing ISM Remains in Contractionary Territory, Near 2 Year Lows
2. ADP Employment Report Falls To 4-Month Low
3. Continuing Claims Rise For Fourth Straight Week To 2-Year High
4. Hudson Employment Fell to a New Record Low of 87.3 in December
5. Strikes in December Should Cut 9200 Jobs From Payrolls
6. Help Wanted Ads fell to a Record Low in November
7. Monster.com Employment Index Falls 14 Points To An 11-Month Low
As you can see, payrolls can go either way, but the odds are certainly skewed greatly in favor of a weak release. With the greenback at a critical juncture relative to many other currencies, including the Euro and Japanese Yen, non-farm payrolls could set the tone for the market as traders fully return from the holidays. Fed fund futures are currently pricing a 100 percent chance of a 25bp rate cut with 36 percent of that chance in favor of a half point cut. Clearly, there is much riding on the December payrolls report but at the same time, even if we do have a strong number, the pessimism that has been engrained in the markets will lead many traders to wonder whether strong payroll growth can be repeated. If payrolls are in excess of 90k, we expect a dollar rally, while a non-farm payroll read of 65k or less would only contribute to further weakness for the greenback. In the most extreme case, a sub-zero result – which we haven’t witnessed in over four years (revised figures) – could give the EURUSD a chance to make a new all-time high above 1.50. As usual, also watch for revisions to the November number because it can easily exacerbate or negate the changes to the current month’s headline figure.
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Written by Kathy Lien and Terri Belkas of Forex Capital Markets LLC, DailyFX.com