Will NFPs Spare the Fed from QE3?

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The biggest problem in the U.S. economy is the lack of job growth. While the unemployment rate in the U.S. has fallen from its high of 10 percent, the two most recent non-farm payrolls reports raised concerns that the U.S. economy is moving in the wrong direction. Many countries in Europe are back in recession and if job growth does not improve, the U.S. could fall victim to the same contraction. When the Federal Reserve last met, they admitted that their economic forecasts were too optimistic and Bernanke pledged to provide additional stimulus if the U.S. economy slowed further. Although one month does not make a trend, if payrolls rise by less than 100k for 3 straight months, it is hard to argue that this does not constitute a meaningful pull back in the U.S. labor market. It is for this reason that Friday’s non-farm payrolls report is extremely important. Economists are looking for a rebound in job growth and if it fails to materialize, the Federal Reserve will have no choice but to join the ECB, BoE and the PBoC in easing monetary policy in August. However if U.S. companies added more than 100k jobs in June, the Fed may be spared from having to pull the trigger on QE3. Even if they haven’t made up their minds quite yet, the dollar should still rally on a good payrolls number because it will lead investors to believe that when it comes to monetary policy, the ECB will be more aggressive than the Fed.

According to this morning’s leading indicators for non-farm payrolls, there is a good chance that the pace of job growth accelerated in June. Challenger Grey & Christmas reported a 9.4 percent decline in layoffs while ADP reported a nice uptick in private sector payrolls. The ADP report shows that a total of 176k workers were added to U.S. payrolls in the month of June compared to 136k the previous month. Jobless claims also dropped to 374k from 386k in the week of June 30th. According to the non-manufacturing ISM report, job growth in the service sector also grew at a faster pace. However, a deeper look into these reports and others tells us that even if payrolls rebound, the uptick could be marginal. The four-week moving average of jobless claims actually increased this month compared to last month while continuing claims edged higher. The manufacturing sector reported a slower pace of job growth but the change was small and therefore not very important. Confidence on other hand declined significantly in June according to both the University of Michigan and Conference Board reports.

While we are still looking for stronger job growth because of the strong correlation between private sector payrolls (white line) and the employment component of manufacturing ISM (orange line) shown in the chart below, we don’t expect payrolls to rise enough to eliminate the possibility of QE3. With this in mind, the dollar could still rise if payrolls exceed 90k and fall if it less than 75k. Of the 82 economists surveyed by Bloomberg, all but 8 expect stronger payroll growth in June.

Arguments for Stronger Payrolls

1. Challenger Grey & Christmas reports 9.4% drop in layoffs
2. ADP reports 176k rise in payrolls vs. 136k in May
3. ISM Non-Manufacturing Employment Component Rises to 52.3 from 50.8

Arguments for Weaker Payrolls

1. 4 Week Moving Average of Claims Rise to 385.7k vs 374.5k
2. Continuing Claims at 3.306M vs. 3.242M
3. ISM Manufacturing Employment Component Drops Slightly to 56.6 from 56.9
4. University of Michigan Consumer Confidence Index hits year to date low
5. Conference Board Consumer Confidence at 62 in June vs. 64.4 in May

These are the forecast for the June Non-Farm Payrolls report.

Change in Non-Farm Payrolls: 93K (Previous: 69K)
Change in Private Payrolls: 100K (Previous: 82K)
Unemployment Rate: 8.2% (Previous: 8.2%)
Change in Manufacturing Payrolls: 8K (Previous: 12K)
Average Hourly Earnings (MoM): 0.2% (Previous: 0.1%)
Average Weekly Hours: 34.4 (Previews: 34.4)

How to Trade Non-Farm Payrolls

The Non-farm payrolls report is a notoriously volatile piece of data to trade as revisions and expectations can impact the market’s reaction as much as the headline number. The best way to trade non-farm payrolls is to stay on the sidelines but for those who insist on trading payrolls, the best currency pair to trade NFPs is generally USD/JPY because of its more logical reaction to U.S. data. The price action of other currency pairs can be diluted by their correlation to risk appetite. In the past, the EUR/USD has seen significant volatility in the minutes that follow the non-farm payrolls release and its near jerk reaction rarely lasts because of the payroll report’s different implications for risk appetite and Fed policy. Even though the direction associated with each month’s move has not always been the same, the immediate reaction is typically reversed once the U.S. stock market opens for trading. Things could play out differently this month because of the implication for QE3, but it always pays to wait for the volatility to settle and for the trend to become more obvious before trading the EUR/USD. The following chart shows the choppy price action in the EUR/USD in the minutes and hours after the non-farm payrolls release.

Kathy Lien
Managing Director

2 thoughts on “Will NFPs Spare the Fed from QE3?”

  1. Hello K,

    It seems to me that ADP is a poor indicator of NFP. Why so? What is the fudamental difference between the two?

    1. ADP is only one of the payroll providers in the US. (Although they are the largest) They are also relatively new at doing this (only a few years) and I’m not sure they have their methodology completely in sync with the NFP report

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