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Employment Preview: Non-Farm Payrolls to Determine If Fed Cuts 25 or 50

Thursday, 06 December 2007 19:27:33 GMT  |  Kathy Lien, Chief Strategist

Expect Non-farm payrolls for the month of November to cause a great deal of volatility in the currency market because traders and analysts are split on whether to expect a strong or weak release.  The one thing that we know for sure is regardless of the outcome someone will be surprised.   The odds are currently skewed heavily in favor of weak job growth but confidence in a disappointing NFP number is low for one solitary yet potent reason: ADP.

The big divergence in the directional forecast means that for ADP, their reputation is on the line, but for currency traders, there is less to lose because the forecast for non-farm payroll growth is only 80k.  It will not take much for the release to surprise to the upside because even if ADP is off by 50k and payrolls are 139k, is an extremely respectable number.  Therefore the more important question to ask is what type of surprise will be needed to make non-farm payrolls dollar positive.  We believe that the whisper number is somewhere around 100-125k which means that even if payrolls prints at 110k for example, we may see only a limited dollar rally.

What Should Traders Watch For

Last month, seven out of the nine indicators that we follow correctly forecasted the stronger payrolls number and now every single one of those indicators except for ADP point to weaker job growth. Of the 81 economists surveyed by Bloomberg, the most optimistic forecast is by Janney Montgomery Scott LLC who expects an addition of 195k jobs while the most pessimistic is Nomura Securities, who expects a loss of 10k jobs.  Janney Montgomery was spot on last month since their overly optimistic forecast was the closest to the actual release. Many banks have also revised their estimates following the ADP release and those forecasts now range between 100k and 125k.  Given that ADP reported private sector payroll growth of 189k, the estimates are still low and reflect the market’s doubt about the accuracy of the ADP report. 

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.  For example, in June 2007, ADP reported private sector payroll growth of 148k from 98k.  However non-farm payrolls that month fell from 188k to 69k while private sector payroll growth fell from 181k to 107k.  As you can see, we cannot use the ADP report exclusively to project job growth especially when it is the only indicator diverging from the entire list of NFP leading indicators that we usually follow.  

Let’s take a look at what the market is expecting tomorrow:

 
What is the market expecting for November?

Change in Non-Farm Payrolls:                       80k Forecast,        166k Previous

Unemployment Rate:                                        4.8% Forecast,     4.7% Previous

Change in Manufacturing Payrolls:               -15k Forecast,      -21k Previous

Average Hourly Earnings:                                3.8% Forecast,     3.8% Previous

Average Weekly Hours:                                  33.8 Forecast,      33.8 Previous

 

The odds are tilted in favor of a weaker NFP number, but the strength of the ADP number cannot be dismissed:

Examining the Leading Indicators for Non-Farm Payrolls

Arguments for Stronger Non-Farm Payrolls Growth

1.       ADP Employment Report Suggests Job Growth in Excess of 200k

Arguments for Weaker Non-Farm Payrolls Growth

 Consumer Confidence Falls for Fourth Straight Month and has hit the its lowest level since October 2005

1. 4 Week Average of Jobless Claims Rise to 335.25k, the Highest Since March
2. Employment Component of Manufacturing ISM Drops Into Contractionary Territory, Lowest in 2 Years
3. Employment Component of Service ISM Drops to 8 Month Low
4. Challenger Reports a 15.9% Increase in Layoffs from October, 4.7% Decrease From Year Prior
5. Hudson Employment Fell to a Record Low of 91.9 in November
6. Monster.com Employment Index Falls 5 Points in November
7. Strikes in November Should Cut 7700 Jobs From Payrolls
8. Help Wanted Ads fell in October

As you can see, payrolls can go either way, but the odds are certainly skewed in favor of a weak release. With many currency pairs still struggling to determine which side of their recent ranges to break, non-farm payrolls could set the tone for the market going into next week’s FOMC meeting.  Fed fund futures are currently pricing a 100 percent chance of a rate cut with 44 percent of that chance in favor of a half point cut.  A lot hinges on the November 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 125k, we expect a dollar rally, but we would need job growth in excess of 200k for the EURUSD to have a chance at making a new all-time high.  As usual, also watch for revisions to the October number because it can easily exacerbate or negate the changes to the current month’s headline figure.

 

Discuss the Outlook for Non-Farm Payrolls and the EURUSD in our DailyFX Forum (Link to Forum)

Keep on Top of Support and Resistance Levels in the EURUSD in our Euro Currency Room

 

By Kathy Lien, Chief Strategist of DailyFX.com

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