Non-farm payrolls dropped by 159k last month, 50 percent more than the market expected. Even though there was a minor upward revision to the August data, the Fed will have no choice but to cut interest rates at the end of the month. Fed fund futures are pricing in a 50bp rate cut by the Oct 29 meeting but we believe that the number is not bad enough to cut by 50bp because the central bank will want save some ammo for the remainder of the year in case the bailout plan fails to stimulate the markets.

Traders Reluctant to Sell Dollars Ahead of House Vote

Interestingly enough, the US dollar initially fell against the Japanese Yen and Euro but quickly recuperated its gains. With the market is embroiled in uncertainty ahead of the House’s vote on the bailout plan, traders were reluctant to aggressively sell US dollars because the ugly NFP number nearly guarantees a passing of the plan. The reaction to the NFP number also tells us that the whisper number could have been somewhere around -200k.

NFP Could Fall by -200k Next Month

Given that this is the ninth consecutive month of job losses in the US economy, and the largest decline in payrolls since March 2003 no one can argue that the labor market is not in bad shape and we expect it to get worse. We haven’t seen the end of job losses and in fact, we expect to see a month of -200k NFPs before the labor market hits a bottom. There was no silver lining in the details of the employment report. The unemployment rate remained at a 5 year high of 6.1 percent while average hourly earnings and weekly hours slipped. Not only are Americans having difficulty finding jobs but they are making less as well. These 2 ingredients spell more trouble for the US economy which is why it is time for the Fed to cut interest rates.

Big Question: Will the EESA Plan Do the Trick?

The House is set to vote on the TARP/EESA plan around 12 to 12:30pm ET and we should see the results in the early afternoon. The approval of the bailout plan could lead to a relief rally in US stocks, but the question here is not whether the plan will be passed but whether it will do the trick of unfreezing the credit markets. House Speaker Pelosi said that she would not schedule a vote on the $700B bailout plan unless passage is certain. The bottom line is banks are not willing to lend to each other. The US economy remains very weak and the crisis of confidence that has frozen the credit markets may not be solved by a plan that focuses on recapitalizing banks and not creating jobs. This shared sentiment has put the Dow within an arm’s reach of 10,000 as a few hundred point swings have become the norm. Therefore we still expect the dollar to remain under pressure against the Japanese Yen and as for the Euro, today’s data is not bad enough to warrant a 50bp rate cut in the Fed funds rate which means that we may also see a relief rally in the EUR/USD.

Kathy Lien is Director of Currency Research at GFT, and runs KathyLien.com.