The U.S. dollar traded sharply lower against all of the major currencies on the back of the shockingly weak non-farm payrolls report. December was the worst month for payrolls since January 2011 with NFPs rising a mere 74k, which is significantly lower than the 241k increase in November and the 197k forecast.
If not for the drop in the unemployment rate, USD/JPY would probably be trading below 104 and the EUR/USD above 1.37. To the complete confusion of market participants, the unemployment rate dropped to 6.7%, the lowest level in 5 years. Investors should not be misled by the decline in the jobless rate because it is a function of a drop in the labor force participation. In other words, the unemployment rate is only falling because more people are dropping out of the work force. The decline in average hourly earnings and weekly hours confirms that Americans are working less and making less which only happens when businesses are less optimistic. While some of this could be related to the weather according to the BLS, there’s no sugar coating the fact that the pool of available workers shrank by more than 750k over the past 2 months. Yet one month doesn’t make a trend and with the BLS saying that the weather affected 273k people who could not get to work, the most for any December since 1977, there’s scope for a big bounce in January especially since the U-6 unemployment rate remained unchanged at 13.1%.
The big question now is whether weak payrolls will slow the pace of Fed tapering or better yet, encourage policymakers to leave asset purchases unchanged this month. Based on the sell-off in the dollar, drop in U.S. yields and recovery in stocks, investors believe that the central bank will be less aggressive with winding down QE in the first half the year. The Federal Reserve also needs to think hard about their unemployment rate threshold because it could be reached by Janet Yellen’s first meeting as Fed Chair in March and unfortunately the unemployment rate is not falling because the labor market is improving. Even if today’s data is distorted by weather, weak payrolls growth highlights the ongoing challenges of high unemployment in the U.S. economy. According to yesterday’s FOMC minutes, the Federal Reserve has not committed to any predetermined course for reducing asset purchases and today’s weak payrolls number is a good reason for the central bank to take a break from tapering this month and wait for the next NFP report which will be released in February before cutting bond buys again. When the central bank meets this month, they will go out of their way to emphasize that rates will not be increased until the jobless rate drops well below 6.5% and to drum this point in harder, they could even lower the target to 6% but that may be a decision relegated to Yellen after she takes office.
Today’s non-farm payrolls report is a major setback for the dollar. While we still believe the greenback will trade higher this year, it could struggle to find buyers between now and the next time the Fed tapers. This means that 105 could be the near term top for USD/JPY and 1.3550 could be a near term bottom for EUR/USD. However don’t expect a significant sell-off in the dollar because many investors are still looking for a big bounce in January.