Friday’s Non-Farm Payrolls report should continue the persistent and debilitating losses that are the hallmark of a recession. We are destined to see the thirteenth month of mounting job losses that is prone to sever the US’ ability to pull out of the economic crisis and restore some level confidence and activity. However, this is not to say that there are no reasons to be modestly optimistic about the labor market report. In fact, currencies and equities are already pricing in the possibility of another 500k decline in non-farm payrolls. The bar has been set very low and in order to disappoint the markets, payrolls may need to fall by 600k.

The leading indicators for non-farm payrolls suggest that even though job losses probably topped 500k last month, the absolute number of jobs may have been less than December. Unfortunately, recent layoff announcements from nearly every sector of the economy indicate that job losses will continue beyond January.

How the Dollar May React to NFPs

In this current market environment, a weak non-farm payrolls report may not be entirely dollar negative. The currency market’s reaction to the labor market number should primarily revolve around risk appetite. A truly negative number could trigger another fit of panic, sending investors into the safety of US dollars and out of any currency that does not hold ranks as a safe haven. On the heels of a weak number, the only currency that the dollar could lose value against is the Japanese Yen. If payrolls fall by 524k (the number of jobs lost in the month of December) or less, we may see renewed risk appetite that could benefit the Euro, Yen, Australian, Canadian, and New Zealand Dollars.

Why Non-Farm Payrolls Could Stabilize Around -525k

Three consecutive months of job losses is hardly characteristic of stabilization, but from a purely technical point of view, there is a decent chance that the amount of job losses in January was comparable to the amount of job losses in December. In the last month of 2008, 524k Americans lost their jobs and another 540k people are expected to have suffered the same fate in the month of January. Of the 10 leading indicators for non-farm payrolls that we typically follow, all point to another month of massive job losses, but the number of jobs lost could be about the same as the month prior.

The employment component of service sector ISM is a very strong leading indicator for non-farm payrolls and its stabilization last month suggests that the amount of job losses may have stabilized (Read my comment on jobless claims and ISM).

Arguments for Better Non-Farm Payrolls

- Employment Component of Service Sector ISM Shows Declines Marginally to 34.4 from 34.5
- Employment Component of Manufacturing Sector ISM Remains at Record Low of 29.9
- ADP Report Exceeds Economic Consensus at -522K from –659k Prior Month
- Challenger Layoffs at 222% compared to 274% in Dec
- Zero Strike Activity

Arguments for Weaker Non-Farm Payrolls

- University of Michigan Consumer Confidence Index Declines Slightly at 61.2
- Conference Board Hits Record Low
- 4-Week Average Claims Hits Highest Level Since Dec 1982
- Monster.com Employment Index Falls 13 Points
- Continuing Claims Hits Record High

Here are the forecasts for January Non-Farm Payrolls:

Change in Non-Farm Payrolls: -540k (-524k Previous)
Unemployment Rate: 7.5% (7.2% Previous)
Change in Manufacturing Payrolls: -145k (-149k Previous)
Average Hourly Earnings (MoM): 0.2% (0.3% Previous)
Average Weekly Hours: 33.3 (33.3 Previous)

Unemployment Rate Could Hit 8%

Going into Friday’s non-farm payrolls report, we are seeing a massive amount of short covering in the currency market. USD/JPY has broken above 90 while the GBP/USD has traded above 1.46. If non-farm payrolls is weak, we could see all of the gains erased and even if they fall less than expected, traders should be skeptical of taking aggressive long positions because job losses anywhere near 500k still represents severe weakness in the US economy. Job losses will continue for at least another 4 months and when all is said and done, the US unemployment rate should be above 8 percent. The only thing that could strike a meaningful recovery in currency and equity market would be a definitive plan from the Obama Administration to save the financial markets and the US economy. Everything else could be faded.

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