NFP Preview Oversold Dollar Confronts Deteriorating US Labor Market

Recent market moves have been driven by expectations about a future economic recovery, but the current situation for the US labor economy is decidedly more dour...

Background

When we wrote this report last month, traders were still focused on the uncertain outcome of the US election and while the prospects for an eventual COVID-19 vaccine were promising, there were no signs of an imminent end to the global pandemic. Fast forward to today and we have no less than three highly-effective vaccines lined up for approval, and citizens in the UK will start receiving their vaccines as soon as next week.

With an end to the global pandemic finally in sight, risk appetite has surged across the board, with global indices seeing one of their best months in decades while higher-yielding currencies like the New Zealand and Australian dollars have surged against safe havens like the Japanese yen and US dollar. However, these moves have been driven by expectations about a future economic recovery, but the current situation for the US labor market is decidedly more dour. Accordingly, economists are expecting Friday’s closely-watched Non-Farm Payrolls report to show that the US economy created just 500k jobs in November, with average hourly earnings rising just 0.1% and unemployment ticking down 10bps to 6.8%:

NFP Preview table showing economic highlights of key global financial dates. Analysed in December 2020

Source: GAIN Capital

NFP Forecast

As regular readers know, there are four historically reliable leading indicators that we watch to help handicap each month’s NFP report:

  • The ISM Non-Manufacturing PMI Employment component ticked up to 51.5 from 50.1 last month, indicating modest employment growth in service sectors.
  • The ISM Manufacturing PMI Employment component dropped nearly 5 points to 48.4, indicating an outright contraction in industrial employment in November.
  • The ADP Employment report printed at 307k, below last month’s upwardly-revised 404k reading and the 433k jobs that economists were expecting.
  • The 4-week moving average of initial unemployment claims dipped to 740k, down from last month’s 787k reading.

As we’ve noted repeatedly over the last few months, traders should take any forward-looking economic estimates with a massive grain of salt given the truly unparalleled global economic disruption as a result of COVID-19’s spread. That said, weighing the data and our internal models, the leading indicators point to a potentially worse-than-expected reading from the November NFP report, with headline job growth potentially rising by “just” 300-400k jobs, though with a bigger band of uncertainty than ever given the current state of affairs

Regardless, the month-to-month fluctuations in this report are notoriously difficult to predict, so we wouldn’t put too much stock into any forecasts (including ours). As always, the other aspects of the release, prominently including the closely-watched average hourly earnings figure, will likely be just as important as the headline figure itself.

Potential market reaction

See wage and job growth scenarios, along with the potential bias for the U.S. dollar below:

Earnings < 0.0% m/m

Earnings 0.0-0.2% m/m

Earnings > 0.2% m/m

< 400k jobs

Bearish USD

Slightly Bearish USD

Neutral USD

400k-600k jobs

Slightly Bearish USD

Slightly Bullish USD

Slightly Bullish USD

>600k jobs

Slightly Bullish USD

Bullish USD

Bullish USD

When it comes to the FX market, there are no two ways about it: The US dollar has been in freefall for the past three weeks as traders bail out of safe haven trades in anticipation of a global economic recovery in 2021. If we see a weaker-than-anticipated jobs report (either on a headline basis or in the average hourly earnings figures), readers may want to consider going long AUD/USD, which has broken above strong previous resistance near 0.7400 and could now play “catch up” with other major pairs. Conversely, if we see even a decent jobs report, traders may look to take profits on US dollar shorts ahead of the weekend. In that scenario, readers could consider shorting GBP/USD, which is testing previous resistance near 1.3500 and could be vulnerable to a deeper pullback if Brexit talks deteriorate over the weekend.


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