How to Trade Non-Farm Payrolls

The US dollar has weakened ahead of the June non-farm payrolls report. According to payroll provider ADP and Challenger Gray and Christmas, the US labor market deteriorated significantly last month. ADP reported a 79k drop in payrolls while Challenger reported a more than 46 percent increase in layoffs. There is absolutely no reason to believe that the labor market has improved since the only argument for stronger payrolls is strike activity, which has fallen by 8300 people. Continuing claims are at the highest level since February 2004 and with Starbucks announcing that they are closing 600 stores, which translate into as much as 12,000 new layoffs, these levels are expected to rise. Non-farm payrolls is always a big market mover, but this time around, we expect unusual volatility since ECB President Trichet will begin his post monetary policy meeting press conference minutes after the NFP release. Here is the link to our non-farm payrolls preview and why we think payrolls could drop by more than 100k. NFP is always dangerous to trade given the possibility of big intraday swings, but USD/JPY should be the currency pair that has the purest reaction to the NFP report because it will not be diluted by the comments from the ECB. It has actually been consolidating for the past 3 trading days and is itching for a breakout. The EUR/USD on the other hand could have a knee jerk reaction to the NFP report and then a sharp reversal as traders tune into Trichet’s comments. Don’t be surprised by 100 pip candles in both directions. The press conference begins at 8:30am ET, but by the time Trichet starts talking, it is usually 8:40 to 8:45am. The market expects a bad number, so a negative non-farm payrolls report will not be enough of a surprise. The current forecast calls for 60k jobs to be shaved off US payrolls. If payrolls come any where near -90k, the dollar would collapse against the Euro as the market questions the viability of a 2008 rate hike by the Federal Reserve. If payrolls on the other hand are better than -40k, it suggests that the labor market is bad but not as bad as everyone may have feared, which could be dollar positive. Also keep an eye on the ECB interest rate decision and the press conference. If Trichet remains hawkish and hints that they have to raise interest rates by more than 25bp this year, then the dollar could fall against the Euro even if NFPs drop by less than expected. If Trichet is noncommittal about future rate hikes on the other hand, the Euro could suffer.

Will the ECB Raise Interest Rates Beyond July?

The ECB is expected to raise interest rates for the first time since 2007 but the quarter point rate hike will not be the big market mover. Instead, the recent price action of the Euro indicates that traders expect hawkish comments from ECB President Trichet. With the annualized pace of Eurozone producer prices growing by the fastest pace on record, consumer spending in Germany doubling expectations and the German unemployment rate falling to a 14 year low, the ECB has to seriously reconsider their original plans to raise interest rates only once this year. The ECB is a central bank that hates surprises and because of that, they always like to prepare the markets weeks if not months in advance of any pending move. That is why they have been telling us that a 25bp rate hike is the appropriate expectation for the upcoming monetary policy meeting. They have also been warning that they are not planning a series of rate hikes. However the ECB may have to backtrack on these words given the recent economic reports. There are 3 possible scenarios for the upcoming interest rate decision that have been outlined in our ECB Preview. The ECB will most likely raise rates by 25bp and leave the door open for further rate hikes, but we wouldn’t rule out a 50bp rate hike or what the ECB has hinted all along, which is one rate hike and that’s it for the year.

British Pound Falls Victim to Weak Economic Data

The British pound has been plagued with bad news this week. Not only did consumer confidence plunge and activity in the manufacturing sector contract even further, but construction sector PMI fell from 43.9 to 38.8, the lowest level since the survey began in April 1997. The housing market has long been the Achilles heel of the UK economy and this latest number tells us that there is no respite in sight. Service sector PMI is due for release tomorrow and if that deteriorates further, the UK economy as a whole may be at risk of falling into a recession.

Australian Dollar Surges on Strong Retail Sales Report

The Australian, New Zealand and Canadian dollars strengthened against the greenback thanks to better than expected economic data and higher commodity prices. Crude oil prices closed at a new record high above $143 a barrel while gold prices are closing in on its 3 month high. Despite the dovish comments from the Reserve Bank of Australia yesterday, retail sales were much stronger than expected. Consumer spending rose 0.7 percent, the strongest pace of growth since November 2007. This is largely due to higher food and gasoline prices since sales at department stores were actually down 0.8 percent. Australian service sector PMI and their trade balance are due for release this evening. Given the drop in manufacturing PMI, service sector growth is likely to be nonexistent.

USD/JPY: Prime for a Breakout

The US dollar has been consolidating against the Japanese Yen for the past 3 trading days and judging from the price action of the currency pair, it is prime for a breakout. The non-farm payrolls report provides the perfect catalyst for a break so expect some interesting price action in the currency pair over the next 24 hours. Despite the 166 point drop in the Dow, the Yen crosses have been mixed with most of the pairs rising except for USD/JPY and GBP/JPY which have been hit by weaker US and UK economic data.

Kathy Lien is the Chief Currency Strategist at FXCM.