Will Non-Farm Payrolls Save the Dollar?

Will tomorrow's Non-Farm Payrolls report save the dollar? Probably not. Over the past 24 hours investors have been selling U.S. dollars aggressively on the premise that recent market developments will discourage the Federal Reserve from raising interest rates in March. We wholeheartedly agree but for non-farm payrolls this means that a weak labor market report will have a larger impact on the dollar than a stronger one. Investors are bracing for a soft release and if payrolls surprise to the downside, the dollar will turn negative for the year but if payrolls surprise to the upside, investors will eye the report with skepticism diminishing the positive impact on the dollar.

In fact there are many reasons for Friday's payrolls report to miss not the least of which is that a correction is expected after last month's surprisingly strong report. Economists are looking for job growth to slow to 190k but based on other labor market related readings, the level of job growth could be even lower. Taking a look at the list below there are many red flags, the most important of which are the sharp declines in the employment component of the two ISM reports. This subcomponent of the non-manufacturing (service sector) index matched its 1 year low. The last time the index fell as much as it did was in January 2015 and that month non-farm payrolls growth slowed to 201k from 329k. The uptick in jobless claims is not a big deal because the 4-week moving average still remains below 300K but the 41.6% rise in layoffs and decline in ADP employment change all point to softer job growth in the month of January. The only arguments in favor of stronger payrolls are continuing claims, which is not that very telling and the Conference Board's consumer confidence report, which is offset by the drop in a similar survey conducted by the University of Michigan. Here's a look at the arguments in favor of weaker/stronger payrolls:

Arguments in Favor of Weaker Payrolls

1. Jobless Claims 4 Week Average Rises to 284K from 275K
2. Layoffs Rise 41.6% according to Challenger Grey & Christmas
3. ADP Beats but still Down to 205K from 267K
4. Employment Component of ISM Non-Manufacturing Drops to 52.1 from 56.3
5. Employment Component of ISM Manufacturing Drops to 45.9 from 48
6. Lower Consumer Confidence According to University of Michigan Index

Arguments in Favor of Stronger Payrolls

1. Continuing Claims Drop to 2.25M from 2.26M
2. Consumer Confidence Soars According to Conference Board Report

For U.S. dollar traders, this means that barring non-farm payrolls in excess of 300K with no downward revisions and a rise in average hourly earnings, any rally in the greenback should be faded. It may not be a terrible idea to even consider taking a small speculative short USD/JPY position ahead of the payrolls report. The main risk for tomorrow's release is wage growth but even then we expect a dollar rally to be limited because Fed officials are coming out in force to express their concerns about the economy. Meanwhile the greenback extended its losses against most of the major currencies today on the back of softer jobless claims, non-farm productivity, durable goods and factory orders as every piece of U.S. data released today missed expectations. These reports reinforced the market's growing belief that the Fed will leave interest rates unchanged in March.

Sterling was the only major currency that failed to benefit from the decline in the U.S. dollar and this was directly related to the Bank of England's monetary policy announcement. As expected the BoE left interest rates unchanged but rather than focus on the improvements in the economy, the monetary policy statement expressed concerns about downside risks to inflation and emerging market growth. In the Quarterly Inflation Report, the central bank also lowered its near term inflation, 2016 wage growth and GDP forecasts. They now expect the economy to grow 2.2% versus 2.5%. The decision to leave rates steady was also unanimous with Ian McCafferty who had been voting for a rate increase since August shifting to neutral.

Meanwhile the euro hit 1.1240, a fresh 3 month high versus the U.S. dollar. The move continues to be driven by short covering as this morning's Eurozone economic reports missed expectations with the Eurozone and German retail PMI numbers falling short of expectations. Dovish comments from Mario Draghi who said the central bank will not surrender to low inflation and ECB member Mersch who sees increased risk of negative rates and warned that the central bank's toolbox is not exhausted did not affect the currency. The market's main focus is the U.S. dollar and that will not change until well after tomorrow's non-farm payrolls report. In the meantime the main level to watch in EUR/USD is 1.1310, the 23.6% Fibonacci retracement of the 2014 to 2015 decline.

All 3 of the commodity currencies performed well today with NZD adding another 1% to its recent gains. The weaker U.S. dollar continues to drive up commodity prices, keeping AUD, NZD and CAD well supported. Our focus has been on the Canadian dollar and the currency will be in play tomorrow with Canada's trade, employment and IVEY PMI reports scheduled for release. Any one of these reports can have a significant impact on the loonie but together on NFP day we expect big moves for USD/CAD. Traders should also expect some volatility in the Australian dollar tonight with the RBA monetary policy statement, construction PMI and retail sales scheduled for release. The sales component of the PMI services report increased last month which signals the potential for an upside surprise that could drive AUD/USD towards 73 cents but the RBA statement could be less hawkish which would offset any positive outcome.