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Will Non-Farm Payrolls Trigger QE3?

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There is an old saying that everything comes in 3s and in the case of Quantitative Easing, there is a very good chance that this could be true. The first round of QE came in November 2008. The second round was in November 2010 and the third round could come as early as September depending upon how Friday's non-farm payrolls report fares. Non-farm payrolls are notorious for triggering sharp volatility across the financial markets but this month, the degree of job growth or lack thereof could actually lead to a major policy change which is why everyone, including the Federal Reserve will be watching the report very closely. Aside from monetary policy, the fate of the dollar also hinges upon payrolls. Up until now, USD/JPY has held above 76, but a weak non-farm payrolls number could push it through that level.

Fewer than 50K Job Growth Could Force QE3

If the Bureau of Labor Statistics reveals that fewer than 50k people found new work in the month of August, the Federal Reserve will be forced to spring into action sooner than they would otherwise prefer. If it was up to the central bank, they would wait for as much data as possible before deciding on more stimulus but investors may not have the same degree of patience and could send the dollar, stocks and bonds sharply lower. If everything comes in 3s, then a weak NFP report is all that it takes to push the Fed to deliver QE3 and more Quantitative Easing makes the dollar less attractive. However if payrolls rise more than 50k, investors will be relieved and the dollar could experience a relief rally. Steady job growth means the central bank can afford to wait and they may opt to postpone another round stimulus to the third anniversary of QE.

The monthly U.S. labor market report is one of the most important economic releases for the U.S. economy. Jobs have long been the missing ingredient in the U.S. recovery and last month's rebound in job growth was a relief because in May and June, the non-farm payrolls report was abysmally weak, leading many people to wonder whether job growth would soon turn into job losses. In August, economists expect payrolls to rise by 70k which is neither good nor bad. At 70k the Federal Reserve will still have to seriously consider more stimulus. The only way some form of QE3 would not happen is if job growth exceeded 150k. Given how off the economist forecasts have been, we cannot rule out a much stronger or weaker release.

Leading Indicators for NFPs Point to Uninspiring Job Growth

However based upon other labor market reports, the odds of weaker job growth overshadow that of stronger one. The four week moving average of jobless claims held steady in August but belt tightening aka fiscal consolidation by the U.S. government has led to job losses. At least 30k public sector jobs are expected to have been lost last month. A labor dispute at Verizon is also expected to reduce the monthly payroll count because the strike did not end until Monday. Verizon submitted 12.5k jobless claims applications during the nonfarm payrolls survey period. According to payroll provider ADP, the private sector added 91k jobs in August, down from 109k the previous month. ADP has been notoriously wrong in predicting private payrolls growth and has been off by at least 55k since the beginning of the year. In the past, it has been known to over count payroll growth but since January, it has undercounted private sector payrolls 5 out of the 7 months. The following chart shows how NFP has been tracking ADP. Unless there is a very big surprise, I wouldn't make too much of the ADP report. In general, the high level of unemployment and the lack of growth have left Americans more pessimistic than ever. According to the Conference Board, consumer confidence is at its lowest level since 2009 and according to the University of Michigan, it is at the lowest since November 2008. Due to the early release of non-farm payrolls, we do not have the luxury of seeing our most reliable leading indicator for NFPs, which is non-manufacturing ISM.

What it Means for the Fed

Job growth has long been the missing ingredient in the U.S. economy. Since the beginning of the year, the Federal Reserve has ignored the problem but they cannot wait any longer. The central bank has a number of tools to choose from but the only one that the market will be satisfied with is QE3. Having come under significant criticism for round 1 and 2 of QE, Bernanke will be very careful about managing expectations and selecting the right option to stimulate the economy. With 3 weeks between the NFP release and the FOMC meeting, the central bank has plenty of time to weigh their options and to discuss it at the 2 day FOMC meeting. However if non-farm payrolls turns out very weak, investors will not hesitate to adjust their positions in anticipation of another round of stimulus. This could be good and bad for the Fed because pre-QE3 rally in equities and sell-off in bond yields will reduce the pressure to act but if they do not give the market what they want, the gains could easily dissipate. Either way, tomorrow's report could very well determine whether the Fed acts in September and because of that, forex traders should expect a sharp move in the U.S. dollar.

Here are the arguments for strong vs. weak NFPs.

Arguments for Better Non-Farm Payrolls:

1. Challenger Reports Decline in Layoffs

2. Continuing Claims Marginally Lower

Arguments for Weaker Non-Farm Payrolls:

1. ADP Reports 91k Increase in Private Sector Jobs

2. 4 Week Moving Average of claims at 410k vs. 407.75k

3. Employment Component of Manufacturing Falls to Nov 2009 Low

4. Conference Board Consumer Confidence at Lowest Level Since 2009

5. University of Michigan Consumer Confidence Report at Lowest Since Nov 2008

These are the forecasts for the August 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. Traders should remember that the first reaction to the non-farm payrolls report is usually not the one that lasts for the rest of the trading day and the best currency pair to trade is generally USD/JPY because of its logical reaction to U.S. data. 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. In the first few minutes of the release, the EUR/USD rallied, then dropped before rebounding once again. This V shaped price action is very typical of the currency pair after NFPs. Only after the first hour did the EUR/USD start to rise more consistently and over the next few hours, accelerated into a trend that lasted for the last rest of the day. 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.

EUR/USD 5 Minute Chart: Intraday move following payrolls report last month:

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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