Now more than ever, the change in non-farm payrolls for the month of March will determine the outlook for the US dollar and US monetary policy. All but one of our leading indicators for non-farm payrolls point to another month of job losses, which means that a negative print alone will not be enough to drive the US dollar lower. The dollar has been rebounding in the days leading up to the non-farm payrolls report and interest rate expectations for the FOMC meeting at the end of this month are strongly skewed in favor of a 25bp versus 50bp cut. We have seen these expectations change on a dime in reaction to incoming economic data and given the fact that the non-farm payrolls report is the most market moving indicator for the US dollar, there is no question that a weak release could alter market expectations significantly.

Could Non-Farm Payrolls Drop by 100k?

In the month of February, the US economy lost 63k jobs, which marked the second consecutive month of negative job growth. This is certainly bad for the US economy, but not as bad as it has been in past recessions. Although Bernanke stopped short of saying that the US economy is already in a recession, the fact that he indicated the possibility of a recession this year is monumental because yesterday was the first time in this business cycle that he had acknowledged what the market has known for some time.

Over the past 3 decades, the US economy has gone through 3 recessions. In each of those 3 recessions, there was a string of job losses that lasted for a minimum of 10 months. Many people argue that the current downturn in growth could be more severe than the recession in the early 2000s due to the triple blow of a housing crisis, credit crunch and skyrocketing commodity prices. If this is true, we will see far more than 3 consecutive months of job losses. Also expect the level of job losses to climb because in each of the past 3recessions, the largest single month job loss was more than 300k! In this context, a 100k drop over the next few months is not only realistic but practically guaranteed.

The strong correlation between the employment component of service sector ISM and non-farm payrolls. The last time, the employment component (blue line) was at current levels, job losses were double the drop in February. Could there be a rebound in NFPs this month given the rebound in the employment component of ISM in February? Yes, but consider it just a rebound before a more serious deterioration in the US labor market.

Jobless Claims Also Hit Recessionary Levels

Jobless claims have also hit recessionary levels. For the first time in over 2 years, jobless claims breached the 400k mark. If we exclude the 2 weeks after Hurricane Katrina, these are actually the worst levels since the last recession. Taking a look back at time when there was a string of consecutive job losses, on average jobless claims were well in excess of 400k. It is important to mention however that the 407k surge is not included in the latest payroll report. It will either be included in the revision or the April non-farm payrolls report. Therefore a rebound in non-farm payrolls in March is not out of the question.

ADP Could Overestimates Non-Farm Payrolls

The primary argument for a rebound in payrolls is the jump in the ADP employment report. However given that ADP has overestimated payrolls growth for the last 6 months, the accuracy of their report, particularly the positive print remains questionable.

Change in Non-Farm Payrolls: -50k Forecast, -63k Previous
Unemployment Rate: 5.0% Forecast, 4.8% Previous
Change in Manufacturing Payrolls: -35k Forecast, -52k Previous
Average Hourly Earnings: 3.6% Forecast, 3.7% Previous
Average Weekly Hours: 33.7 Forecast, 33.7 Previous

Of the 79 economists polled by Bloomberg, the most optimistic forecast is by Argus Research who calls for 64k job growth. The most pessimistic is ING Financial who is calling for job loss of -150k. Most economists expect a negative print, but the range of estimates is extremely wide which means that traders should expect sharp volatility in the US dollar and the financial markets in general on the back of the non-farm payrolls release.

In order to determine the strength of non-farm payrolls, we look at 10 pieces of data that we call the leading indicators for non-farm payrolls. Five out of the ten releases point to greater job losses, four points to an improvement and one is neutral. More specifically, jobless claims are on the rise, consumer confidence hit a 4 year low, Challenger Gray and Christmas announced a 9.4 percent increase in planned layoffs by US firms and strike activity cut 1100 jobs from US payrolls. On the other side of the spectrum, we had the rebound in ADP, the improvement in the employment component of manufacturing ISM (although it is still contractionary) and the increase in online job ads. The employment component of service sector ISM is usually a very reliable leading indicator for NFPs, but it held steady last month which makes NFPs a particularly difficult call.

Arguments for Weaker Non-Farm Payrolls

1. Challenger Report Showed a 9.4% Increase in Planned Layoffs
2. Jobless Claims: 4 Week Moving Average Continues to Climb
3. Continuing Claims: 4 Week Moving Average On the Rise
4. Consumer Confidence Hits 6 Year Lows
5. Strike Activity Increased by 1100

Arguments for Stronger Non-Farm Payrolls

1. ADP Employment Report Increases 8k
2. Help Wanted Ads Remain Steady
3. Monster.com Online Ads Increased in March
4. Employment Component of Manufacturing ISM Rebounds

Neutral

1. Employment Component of Non-Manufacturing ISM Holds Steady

Will March Non-Farm Payrolls be Better or Worse than February?

Nearly all of the leading indicators for non-farm payrolls indicate that March was a month of job losses. However, even though the odds are skewed towards greater job loss, conflicting reports make it important not to rule out the possibility there was less jobs lost in March than there was in February. Either way, the state of the labor market will grow increasingly worse in the coming months even if there is a rebound in March. For traders, if non-farm payrolls are better than -63k, the dollar should rally and rate cut expectations will grow in favor of a 25bp rate cut because everyone will believe that the US labor market has hit a bottom. If it is worse, expect the US dollar to not only resume its slide, but make a run for a new record low in the coming weeks. As usual, also watch for revisions to the February figure because it can easily exacerbate or negate the changes to the current month’s headline number.

The most important thing to remember is not to be misled by any improvements because the labor market will continue to deteriorate. Bernanke has already warned that the unemployment rate will be on the rise and because of that, we have still not seen the real bottom in the US dollar.

Richard Lee is a Currency Strategist at FXCM.