The U.S. non-farm payrolls report is always a big mover for the U.S. dollar and all of the major currencies but this month’s report could be more market moving than usual. First, participation is lower with many U.S. traders off for the July 4th holiday weekend. This is the most popular weekend for summer vacations and trading desks are generally staffed with junior traders who are unlikely to take major positions. However this NFP report is also a very important one because last month, the Federal Reserve said they are close to cutting interest rates but how quickly they move depends on data. In that case, there’s no single economic report as important as the jobs report. If job growth falls short of expectations, the market could immediately move to pricing in a July interest rate cut. While Fed fund futures are discounting 100% chance of easing this month, the modest decline in the dollar since the June 19th meeting is a sign that FX traders are unprepared for a cut. So if the jobs report is weak, we could see a broad based decline in the greenback.
Part of the reason why the U.S. dollar is not significantly weaker is because job growth is expected to recover this month, a prospect confirmed by U.S. policymakers like Fed President Bullard. Last month’s report was ugly with only 75K jobs created in the month of May. Wage growth also weakened for the third month in a row. While there’s no doubt that the U.S. economy is slowing, it is hard to imagine that less than 80K jobs were created two months in a row. With that in mind, the greenback should be trading much lower given the recent decline in Treasury yields – 10 year rates fell to a 2.5 year low on Wednesday.
Taking a look at the leading indicators for non-farm payrolls, the outlook for the labor report is mixed. While ADPWealth Strength IndexADP is Extremely Up and trending Up reported an increase in private sector payroll growth, the rise was less than anticipated. ISM reported weaker job growth in the service sector last month but they incorrectly predicted stronger growth in May so this could be a correction of last month’s misalignment. Confidence is down across the board and the 4 week moving average of jobless claims increased. The primary reason why job growth is expected to be stronger is because last month’s report was so weak.
Arguments in favor of stronger jobs report
- ADPWealth Strength IndexADP is Extremely Up and trending Up rebounds to 102K vs. 41K
- Challenger Layoffs at 12.8% vs. 85.9% month prior
- ISM reports rise in manufacturing jobs
- Continuing Claims Drop
Arguments in favor of weaker jobs report
- ISM reports weaker job growth in June (but miscalled stronger growth in May)
- 4 Week Moving Average of Jobless Claims Rises
- Consumer Confidence Index Drops 10 points in June
- Lower University of Michigan Consumer Sentiment Index
When it comes to trading NFPs, the absolute amount of job growth is not the only thing that matters. Revisions, average hourly earnings and the unemployment rate are all important. This month, economists predict 164K job growth, average hourly earnings of 0.3% and a steady unemployment rate of 3.6%.
Scenario #1 – If non-farm payrolls exceed 165K and wage growth rises by 0.3%, the best currencies to trade will be EUR/USD, AUD/USD and NZD/USD. The ECB may not be ready to cut interest rates in July but easing later this summer is certainly on the table. The Reserve Banks of Australia and New Zealand have also made it clear that further rate cuts may be necessary this year. They are the 2 most dovish central banks and their currencies are the most vulnerable to a correction on the back of a good U.S. jobs report.
Scenario #2 – If non-farm payrolls rise between 135K to 165K but last month’s numbers are revised materially higher, the U.S. dollar’s reaction will be determined by the pace of wage growth and the unemployment rate. If the rest of the components are strong, we should also see the dollar rise against the euro, Australian and New Zealand dollars. USD/JPY will rally as well but this pair is less attractive because investors could question how much of a difference a muted increase makes for the Fed.
Scenario #3 – However if payroll growth is less than 135K and there’s no material upward revisions to the May report and wage growth fails to accelerate, then the best pairs to trade will be USD/JPY which could drop below 107 and USD/CHF which could fall below .9750. If the labor market report is mixed with job growth accelerating but wage growth slowing or the unemployment rate rising then the dollar’s reaction depends on biggest surprise.
USD/CAD will also be on the move with Canadian labor market numbers scheduled for release. Canada’s economy has been on fire but in the context of slower global growth and a very strong currency it won’t take much to disappoint CAD traders. USD/CAD is trading at 8-month lows and a small miss could trigger a voracious short squeeze ahead of next week’s Bank of Canada monetary policy announcement.