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Forex Research - NFP Preview: Why a Weak Number May Not Stop the Dollar's Rise

NFP Preview: Why a Weak Number May Not Stop the Dollar's Rise Last Updated 11/6/2008 4:26:17 PM EST (GMT +5)

TODAY’S BIGGEST PERCENTAGE MOVERS

AUD/JPY ( -177 pips or -2.64%)

AUD/USD (-170 pips or -2.48%)

EUR/JPY ( -270 pips or -2.11%)

THE STORIES IN THE CURRENCY MARKET

  • USD: Why a Weak NFP Number May Not Stop the Dollar’s Rise
  • EUR: ECB is Hopelessly Behind the Curve
  • GBP: 150bp Rate Cut, Rates at 50 Year Lows
  • CAD: Watch Out for Decline in Canadian Employment
  • AUD: Stronger Employment Report Fails to Help the Aussie
  • NZD: Unemployment Rate Ticks Higher
  • JPY: Another 4.8% Drop in Dow Drags Carry Trades Lower

EXPECTATIONS FOR UPCOMING FED MEETINGS

 

** PERCENTAGES MAY NOT ADD UP TO 100% BECAUSE OF THEPROBABILITY OF LARGER OR SMALLER MOVES BEYOND THOSE SHOWN ON THIS TABLE

NFP PREVIEW: WHY A WEAK NUMBER MAY NOT STOP THE DOLLAR’S RISE

Even though the US economy has not officially entered a recession, the US labor market has. October will mark the tenth consecutive month of net job losses. The market currently projects a loss of 200k jobs last month, but given the trend of job losses in past recessions, there is a growing chance that we may finally see job losses top 300k. There is every reason to believe that the US labor market deteriorated significantly in the month of October. The credit crisis hit a peak, forcing companies to cut back. No one can argue that the US economy is in the worst shape since the Great Depression. Since we have seen a single month job loss of more than 300k in every recession over the past 30 years, there is no reason to believe that this time, it will be different. However a weak job number may not necessarily be negative for the US dollar if it triggers another wave of risk aversion, forcing investors into the safety of the low yielders.

Impact of Weak NFPs on Currencies

If non-farm payrolls fall more than 250k, it would be initially negative for the US dollar, but when the US stock market opens, we could see the dollar rally. Traders need to remember that the dollar is appreciating not because of the strength of the US economy, but because money flocks into low yielding currencies during a global recession. In a very short period of time, the US dollar has become the second lowest yielding G7 currency. A weak labor market number will mean two things – more weakness for US equities and another 50bp rate cut from the Federal Reserve next month. By extension, it will lead to weakness in USD/JPY, EUR/USD, GBP/USD and all of the Japanese Yen Crosses. The only way to avoid another round of selling would be if non-farm payrolls dropped by less than 150k.

Arguments for More than 200K Drop in Non-Farm Payrolls

Every month, we take a look at 9 leading indicators for non-farm payrolls and this month, every single one of them points to large job losses. Consumer confidence has hit a record low, layoff announcements hit a 5 year high while the employment components of service and manufacturing both point to continued job losses. Not only are more Americans being laid off, but those who have already lost their jobs are having a very tough time finding new ones. It is rare that we get such a strong signal about the state of the labor market, but the layoff announcements coming from all different sectors of the US economy confirm that we will see large scale job losses. This is the main reason why US equities have sold off aggressively over the past 48 hours, sending investors into the US dollar and Japanese Yen, the 2 lowest yielding currencies.

Here’s how the leading indicators stack up:

  • 1. Employment Component of Service Sector ISM Dropped to Lowest Level on Record
  • 2. Employment Component of Manufacturing Sector ISM fell to Lowest Level Since 1982
  • 3. ADP Report Private Sector Job Losses of -157K
  • 4. Challenger Layoffs Up 79%, a 5 Year High
  • 5. Consumer Confidence Falls to Record Low
  • 6. Continuing Claims Hit Lowest Level since 1983
  • 7. Average Claims is at 475K, Well Above the Yearly Average of 393K
  • 8. Strike Activity Rises 27K
  • 9. Monster.com Index Hits 3 Year Low

Since the service sector ISM report covers 90 percent of the US economy, it is not surprising that the employment component of the report is a very strong leading indicator of non-farm payrolls. The sharp drop in the employment component of the report signals an equally large decline in non-farm payrolls.

 

The Upside of Losing -300K Jobs

Of the 77 economists surveyed by Bloomberg, the most optimistic forecast is by Argus Research who calls for only an 85k drop in non-farm payrolls and the most pessimistic is Goldman Sachs, who is calling for a 300k drop. The unemployment rate is expected to jump from 6.1 to 6.3 percent, matching the 5 year high.

Don’t expect the job losses to end in October. In the past 3 recessions, job losses have extended beyond 10 months. The longest stretch of job losses in the past 30 years was between 1980 and 1982, where we saw 17 consecutive months of job losses. With market caps evaporating and lending still frozen, US companies will continue to tighten their belts. A loss of 300k jobs would not be all bad because it would suggest that we are nearing the bottom in the labor market. However if job losses fall short of 300k, it will just be a matter of time before it ends up breaking that level at which time, we will be looking for a bottom in the labor market.

 

EUR/USD: ECB IS HOPELESSLY BEHIND THE CURVE

It was the morning of rate cuts with the European Central Bank, Bank of England and the Swiss National Bank all cutting interest rates. On a day when the Bank of England shocked the markets with a 150bp rate cut, the ECB and the SNB’s half point cut seemed very small in comparison. Every major central bank is worried about growth but not as worried as the ECB. Unlike King who openly admitted that the economy is in a recession, when asked the same question, Trichet simply said “we will see.” On future rate cuts, he said that the ECB never pre-commits. If Trichet was serious about cutting interest rates aggressively, he would not be qualifying his comments on inflation and future rate cuts. In his post meeting press conference, ECB President Trichet was not as bearish as he could have been given the sharp deterioration in growth. He spent the majority of his time discussing inflation and how it is set to ease but skirted over growth and the economic outlook. Larger rate cuts were discussed but the decision to cut by 50bp to 3.25% was unanimous. Compared to the BoE, the ECB’s tone is less dovish. The ECB is a more conservative central bank and it is clear that their monetary policies are more restrictive. They have only cut rates by 75bp this year when taking into account their rate hike in July. More rate cuts will come from the ECB, but Trichet’s comment about not pre-committing to rate cuts indicates that they will not be making rate cuts in excess of 100bp like the BoE. Trichet feels that he has already done a lot by cutting interest rates twice in 1 month.

GBP/USD: BOE CUTS BY 150BP, TAKES INTEREST RATES TO 50 YEAR LOWS

In yesterday’s Daily Currency Focus, we argued about the need for a 100bp from the Bank of England. Although this was well beyond the market’s 50bp forecast, it was still less than what the Bank of England eventually delivered. Earlier this year, Mervyn King was still being criticized for being behind the curve. A month ago, he shed that image by announcing plans to take equity stakes in banks. King realizes that he has a seismic challenge ahead of him and today’s move confirms that the economy is in a recession. This has compelled the BoE to take insurance out on future growth by making a much larger than expected rate cut.UK interest rates are now at 3.00%, the lowest in more than 50 years. What makes today’s move even more groundbreaking is the fact that the BoE has never cut by more than 50bp since it was granted independence, and did not cut by more than 100bp even during the last recession in the early 1990s. King is sending a strong message to the markets that they can trust him to proactively fight off the recession. More rate cuts are expected from the BoE, but certainly not by the same degree that we have seen today.

OIL PRICES HIT $60 A BARREL, DRIVING AUD NZD CAD LOWER

The Australian, New Zealand and Canadian dollars continued to be dragged down by risk aversion, which has driven equity and commodity prices lower. Oil prices dropped to $60.16 a barrel, the lowest level since March 2007. The move in oil prices is due entirely to the continued liquidation of risky assets. Economic data from the 3 commodity producing countries was mixed with Australian employment numbers beating expectations but New Zealand employment and Canadian IVEY PMI numbers missing them. The Australian labor market continues to be surprisingly resilient, with 34k new jobs added last month. In an environment where the US economy is about to report its tenth consecutive month of job losses, Australia has only had 2 months of job losses during that same period. The unemployment rate also remained unchanged at 4.3 percent. New Zealand on the other hand reported an uptick in unemployment with the jobless rate rising from 3.9 to 4.2 percent. As for Canada, the IVEY PMI report fell to the lowest level in 3 years. Going into the Canadian employment report tomorrow, the drop in the employment component of the IVEY report suggests that we could also see the US’ northern neighbor report negative drop growth.

USD/JPY: ANOTHER 4.8% DROP IN THE DOW DRIVES CARRY TRADES LOWER

On the fear that Friday’s non-farm payrolls report could be particularly ugly, the Dow Jones Industrial has fallen close to 5 percent. This has dragged USD/JPY as well as the other Japanese Yen crosses down with it. As we have indicated in yesterday’s Daily Currency Focus, the recession trade is on and that will lead to further strength in the Japanese Yen. However as the Yen rises, it spells more trouble for Japanese Corporations and for automakers in particular. Toyota has announced that the strength of the Yen has forced them to cut their profit forecasts by 56 percent. Honda has also cut its profit forecast, but that was earlier this year, when the Japanese Yen was at lower levels against the Euro and US dollar. The CEO has called for intervention to weaken the Japanese Yen. Although more verbal intervention may be possible, we do not expect any physical intervention in the currency market.

USD/JPY: Currency in Play for the Next 24 Hours

USD/JPY will be the currency in play for the next 24 hours with the US non-farm payrolls release expected at 8:30am ET or 13:30 GMT.

Although USD/JPY is currently in the range trading zone, we have picked this pair as our focus for Friday because it should have the cleanest reaction to the US non-farm payrolls report. The sell-off today has taken the pair below key Fibonacci support, which has now turned into resistance. The 38.2% Fibonacci retracement of the August to October sell-off sits not far from current levels at 98.45. As long as the currency pair remains below that price point, we could see a test of 96.60, the first standard deviation Bollinger band. Below that, would be a move into the sell zone, which would open the door for more losses. If 98.45 is taken out, there is no major resistance in USD/JPY until 100.

 

About The Author

Lien has extensive knowledge within the interbank market, particularly in trading spot FX and options. She has written for numerous publications, is frequently quoted on financial media outlets, and is the author of several books, including Millionaire Traders. Read more >>

DISCLAIMER: This forum and the information provided here should not be relied upon as a substitute for extensive independent research before making your investment decisions. Global Forex Trading is merely providing this column for your general information. This forum and its information does not take into account any particular individual’s investment objectives, financial situation, or needs. All investors should obtain advice based on their unique situation before making any investment decision based upon this forum or any information contained within. In addition, any projections or views of the market provided by the author may not prove to be accurate. Global Forex Trading and Kathy will not be responsible for any losses incurred on investments made by readers and clients as a result of any information contained in this column. Global Forex Trading and Kathy do not render investment, legal, accounting, tax or other professional advice. If such advice is sought, or other expert assistance is required, the services of a competent professional should be sought.

 

 

 

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