Why Non-Farm Payrolls Could Top -100k

September 4, 2008

On Friday, we are expecting the number one most market moving release for the US dollar - August Non-farm payrolls. Based upon the leading indicators for NFP, there is a decent chance that job losses could have topped 100k last month.

I wrote this special report for GFT. You can catch my daily report on GFT’s Research Page

The US dollar hit a 7 month high against the Euro following the hotter than expected service sector ISM number, but rather than buying into the dollar rally, we are more worried about the sharp drop in the employment component of service sector ISM, which has a close to 80 percent correlation with non-farm payrolls. According to the following chart, there should have been a steep decline in non-farm payrolls last month. Technicians would argue that the drop could actually be more than -100k.

Rising prices have forced many companies to cut back. Layoffs have become a way of life and we are seeing evidence of that in both the manufacturing and service sectors. Continuing claims hit the highest level in 5 years, confirming that the number of people needing employment benefits continue to rise. The US labor market is in bad shape and it will get progressively worse. The ADP employment survey has consistently overestimated non-farm payrolls and for that reason, the 33k drop last month could translate into a -100k decline in NFP.

nfp0908

Here are the arguments for and against a big drop in non-farm payrolls. As you can see, the arguments are significantly skewed towards a weak number.

Arguments for a More than 100k Drop in Non-Farm Payrolls

1. Employment component of Service Sector ISM Fell from 47.1 to 45.4
2. Employment component of Manufacturing Sector ISM Fell from 51.9 to 49.7
3. Continuing Claims Hit a 5 Year High
4. ADP Reports -33k in Private Sector Payrolls
5. Challenger Layoffs Increased by 11.7%
6. Strike Activity Increased by 4200

Arguments for a Less than 100k Drop in Non-Farm Payrolls

1. Consumer Confidence Increases from 51.9 to 56.9
2. Monster.com Employment Index Increases from 157 to 159

EUR/USD Still Headed for 1.40

The market is currently expecting non-farm payrolls to drop by -75k and the unemployment rate to remain unchanged at 5.7 percent. Of the 76 economists surveyed by Bloomberg, only 11 expect non-farm payrolls to crack the -100k mark. For traders, this means that
-100k is the make it or break it point for the US dollar. If less than -100k jobs were lost last month, the dollar could continue to rise. If more than -100k jobs were lost, expect a reversal in the US dollar.

However even if the dollar sells off on non-farm payrolls, don’t expect that to be a top. We have argued in the past that the dollar can rally even if the US economy continues to weaken. On a purchasing parity basis, the US dollar is still undervalued against the Euro and British pound. With the markets waiting for the Federal Reserve to deliver their first rate hike in 2 years and the European Central Bank to cut interest rates for the first time in 5 years, the expectations for completely diametric monetary policy is exactly what will drive the EUR/USD to 1.40 over the next few months.