NFP Preview: Will Payrolls be Strong Enough to Extend the Rally?

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Over the past month, we have seen a number of improvements in the U.S. economy yet Federal Reserve officials continue to talk of the need for more transparency and stimulus. This of course is related to their concerns about the European sovereign crisis and its impact on the financial markets but how quickly and aggressively they choose to change the guidance and language of their FOMC statement will partially hinge upon Friday's non-farm payrolls report. There are many reasons to believe that the U.S. labor market continues to improve gradually despite the layoffs in the banking sector. In fact, nearly every single one of the leading indicators that we use to forecast the direction of payrolls points stronger job growth.

Private sector payroll provider ADP for example reported an increase of 206k jobs last month, a nice improvement from the 130k jobs added by U.S. companies in October. ADP has not been the perfect leading indicator for NFPs, but given the consistency of other labor market reports there is a good chance that the increase in job growth reported by ADP will carry through to NFPs. For the past 4 weeks, weekly jobless claims were at or below 400k and for this reason the four week moving average is also below 400k for the first time since April. Perhaps the improvement in consumer confidence can be explained by the improvement in the labor market. Both the University of Michigan and Conference Board reports increased in the month of November while Challenger Grey & Christmas reported a 13 percent decline in layoffs. The only indicator that pointed to slower job growth was the employment component of manufacturing ISM which fell from 53.5 to 51.8.

A good non-farm payrolls report will be a step towards recovery but Federal Reserve officials will continue to have their reservations until there is a credible solution to Europe's debt crisis. Jobs have long been the missing ingredient in the U.S. recovery and for the time being, job growth has not been consistently strong enough to make a big dent into the unemployment rate. With Europe expected to remain in the midst of crisis in the New Year, the U.S. could still see slower growth which is why QE3 is not off the table. Nonetheless, a strong non-farm payrolls report will be something to celebrate, especially on the heels of the coordinated increase in liquidity provided by central banks this week

Leading Indicators for NFPs Point to Solid Job Growth

Here are the arguments for strong vs. weak NFPs.

Arguments for Better Non-Farm Payrolls:

1. ADP Reports Increase of 206k Private Sector Jobs

2. Challenger Reports 12.8% Drop in Layoffs

3. University of Michigan Consumer Sentiment Index at 5 Month High

4. Huge Jump in Consumer Confidence According to Conference Board Report

5. 4 Week Moving Average of Claims Below 400k, First Time since April

6. Continuing Claims Decline

Arguments for Weaker Non-Farm Payrolls:

1. Employment Component of Manufacturing ISM Declines Slightly

These are the forecasts for the November Non-Farm Payrolls Report:

How to Trade Non-Farm Payrolls

The Non-farm payrolls report is a notoriously volatile piece of data to trade as revisions and expectations also impact the market's reaction. The best currency pair to trade NFPs is generally USD/JPY because of its more logical reaction to U.S. data. The price action of other currency pairs is often diluted by their correlation to risk. If non-farm payrolls are strong, USD/JPY could finally muster the strength to close above 78. If it is weak, we expect the currency pair to make a run for 77.00. Considering how heavily skewed the leading indicators for non-farm payrolls are to a stronger report, job growth less than 100k would be a major disappointment for the market. Traders should remember that the knee jerk reaction in the EUR/USD to the non-farm payrolls is rarely the market's true reaction and the one that lasts for the rest of the day. Even though the direction associated with each month's move has not always been the same, the immediate reaction is typically not sustained, and frequently reverses into a more substantial move that lasts for the course of the trading day. The following chart shows how the EUR/USD responded after last month's NFP report. The EUR/USD rallied the first five minutes after the NFP release, then quickly gave up all of its gains and traded down as much as 140 pips within the next 2 hours. So when it comes to trading non-farm payrolls, it pays to wait for the volatility to settle and for the new trend to emerge before trading the EUR/USD.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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