How to Trade the Dollar AFTER Non-Farm Payrolls

With less than 24 hours to go before the U.S. non-farm payrolls report, we've seen limited moves in the U.S. dollar. The greenback traded lower against most of the major currencies, which is not surprising as investors are worried that the labor market report will fail to live up to Federal Reserve's expectations. Throughout last month, Fed officials made it clear that interest rates could rise for the first time in October and the decision hinges upon further strength in the labor market. So if non-farm payrolls rise by 200K or more AND the unemployment rate remains unchanged AND average hourly earnings growth accelerates, the light for raising interest rates will flash green. However if payrolls fall short or average hourly earnings growth slows, the Fed's decision becomes tougher and the dollar will suffer as a result. Yet handicapping non-farm payrolls is only interesting for the next 15 hours. What we are more interested in is how to trade the dollar after the NFP report.

To trade the dollar effectively it is important to realize that there's a misalignment in market expectations. The Fed said October is in play and most economists believe that rates will rise before the end of the year but according to Fed fund futures, investors are only pricing in 16% chance of a hike this month and 43% chance of a move in December. So while a weak NFP report would be disappointing, a strong report would be more surprising. In other words, we expect a stronger reaction to a positive than a negative labor market report. Either way, we encourage traders to exercise patience and warn against jumping in on the move immediately after the report. A weak number will provide an attractive opportunity to buy USD/JPY lower or sell EUR/USD higher for a move in rates later this year. The dollar will pop on a strong number and traders should also look to join the move on shallower retraces.

We have a number of reasons to believe that jobs growth increased in the month of September. According to the ADP report, companies added more workers to their payrolls last month. The 4 week moving average of jobless claims declined as did continuing claims. Confidence on the other hand was mixed with the Conference Board reporting an uptick in sentiment and the University of Michigan reporting deterioration. However a good number is not a done deal because Challenger Grey & Christmas reported a 93.2% increase in layoffs and job growth slowed in the manufacturing sector according to ISM. More importantly, the non-manufacturing ISM report, our most reliable leading indicator for NFPs will not be released until after NFP. Nonetheless, given the overall trajectory of the U.S. economy, we are looking for healthy labor market numbers.

Arguments in Favor of Stronger Payrolls

1. ADP Reports Stronger Private Employment Change
2. Conference Board Reports Uptick in Confidence
3. 4 Week Moving Average Declines
4. Continuing Claims Decline

Arguments in Favor of Weaker Payrolls

1. Challenger reports 93.2% increase in layoffs
2. University of Michigan Consumer Sentiment Index Declines
3. Employment Component of ISM Manufacturing Falls

The best performing currency today was the Canadian dollar. USD/CAD reversed sharply over the past 48 hours. This week's stronger GDP report along with news that the Canadian government will open up mineral exploration to the private sector helped the currency find a bottom. Oil prices also ended the day unchanged.

The recovery in commodity currencies is a reflection of the market's relief that China did not report deterioration in manufacturing activity. The PMI index rose to 49.8 from 49.7 with the non-manufacturing index holding steady at 53.4. The biggest news out of China last night was the decision to end the flash release of the Caixin PMI indices. These reports typically give the market an initial more accurate read on Chinese economic activity but now we will only receive the final numbers 45 minutes after the government's official report. This is clearly aimed at minimizing noise and volatility and managing market expectations but we worry that it will distort everyone's assessment of China's economy. Nonetheless both the Australian and New Zealand dollars rebounded on the PMI numbers with AUD further lifted by an uptick in its own release. The Australian economy isn't doing nearly as bad as economists fear and hopefully tonight's retail sales report will show the same.

The Euro and British pound ended the day unchanged versus the U.S. dollar. The Eurozone confirmed its manufacturing numbers but the German data were revised lower. More importantly, manufacturing activity in the U.K. beat expectations with the PMI index rising to 51.5 versus 51.3 expected. The drop in industrial production and the CBI orders index had everyone bracing for a weak report. While this did not help sterling much today, we believe that it will contribute to a bottoming out in the currency that we expect to happen very soon.