It’s time for non-farm payrolls. The Federal Reserve lowered interest rates by 50bp on Wednesday and indicated that they will be cutting rates further in the months to come. How much and how quickly they reduce interest rates again will be dependent upon the level of job growth in the month of January. With the currency market in limbo after the FOMC announcement, non-farm payrolls should clarify the near term outlook for the US dollar.

In order to determine the strength of non-farm payrolls, we typically look at 10 pieces of data that we call the leading indicators for non-farm payrolls. Unfortunately, this time around, non-farm payrolls are being released on the first of the month, which means that 3 of the most important indicators that we follow (Challenger Layoffs, Manufacturing and Service Sector ISM) will not be released until after the NFP report. Although this makes it difficult to pinpoint the exact range for non-farm payrolls growth, the data that has been released suggests that there will be strong rebound from last month’s exceptionally weak number. Since December, average jobless claims have ticked lower, help wanted ads have increased and according ADP, US companies boosted their payrolls by 130k. We believe that job growth will be between 65k and 85k, because there is still reason for concern: confidence is mixed, continuing claims point to a weak labor market and the Hudson employment index remains at a record low.

In the month of December, job growth was abysmal with only 18k jobs added to US payrolls. Without the help of the government, the private sector actually lost 13k jobs. The weakness in the labor market is one of the main reasons why the Federal Reserve has cut interest rates 150bp since the last NFP release. We believe that the Federal Reserve will begin to slow their pace of rate cuts, but if job growth fails to live up to the market’s expectation once again, the Fed could realistically deliver back to back half point cuts. In fact, according to Fed fund futures, the market is already pricing in a 70 percent chance that interest rates will be taken down to 2.5 percent at the March 18 monetary policy meeting. However we have all seen rate cut expectations shift dramatically in the weeks leading up to the most recent FOMC decision. If job growth was in excess of 100k during the month of January, traders could flip their bets and favor a return to gradualism. Simply speaking, a strong number would be positive for the dollar because it would mean that we only need 25bp more in March while a weak number will be negative because it would call for another half point cut.

What is the market expecting for January NFP?

Change in Non-Farm Payrolls: 70k Forecast, 18k Previous
Unemployment Rate: 5.0% Forecast, 5.0% Previous
Change in Manufacturing Payrolls: -20k Forecast, -31k Previous
Average Hourly Earnings: 3.9% Forecast, 3.7% Previous
Average Weekly Hours: 33.8 Forecast, 33.8 Previou

What Should Traders Watch For

Of the 7 leading indicators for non-farm payrolls that have been released ahead of the NFP number, only 5 favor stronger job growth. The biggest reason to believe there will be a strong rebound is the ADP survey which reported 130k private sector jobs in the month of January. ADP has overestimated private sector job growth in the past 2 months, but directionally they tend to be fairly accurate. Help wanted ads also increased slightly and the four week moving average of jobless claims dropped from 343k to 325k. There are still ongoing strikes, but of the 9200 work stoppages in December, 5200 jobs have been recovered. However independently, each of these reasons are not very powerful which is why we believe that there will not be a blowout non-farm payrolls number. The latest rise in jobless claims was the biggest since Hurricane Katrina. Of the 80 economists surveyed by Bloomberg, the most optimistic forecast is by Deutsche Bank who expects an addition of 160k jobs (they have increased their forecasts sharply after ADP) while the most pessimistic is by National Bank Financial, who expects an increase of only 5k jobs. The dollar should rally on job growth in excess of 90k and sell-off if job growth is less than 60k.

Arguments for Stronger Non-Farm Payrolls Growth
1. ADP Report Says US Added 130k Private Jobs in January
2. Help Wanted Ads Increase in January
3. 4 Week Average of Jobless Claims Falls from 343.75K to 325.75K
4. Strikes in January Cut 4000 Jobs Instead of 9200

Arguments for Weaker Non-Farm Payrolls Growth
1. Consumer Confidence Increased According to UMich but Decreased According to Conference Board
2. Hudson Employment Remains at a Record Low
3. 4 Week Average of Continuing Claims Tick Higher

The following charts compare the monthly releases of ADP with private sector payrolls and total non-farm payrolls. Generally speaking, the two releases are correlated, but as with everything, the correlation is not perfect. Last month was the perfect example when ADP reported private sector payroll growth of 40k but there was actually a net job loss. Therefore even though ADP reported 130k payroll growth in the month of January, we cannot rely on it exclusively.



Examining the Leading Indicators for Non-Farm Payrolls

As you can see, most of the leading indicators for non-farm payrolls point to stronger job growth, but the US economy is deteriorating and companies like Yahoo, Sprint, Lehman Brothers and General Motors recently announced new layoffs. The Fed is watching the labor market very closely and so will we because it will be a big factor in determine and how quickly and how sharply interest rates are cut again. For the currency market, this will have a big impact on the US dollar and carry trades. As usual, also watch for revisions to the December number because it can easily exacerbate or negate the changes to the current month’s headline figure.

Richard Lee is a Currency Strategist at FXCM.