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US: NFP Preview − Will Non−Farm Payrolls Push the Fed to Cut Interest Rates?

Thu, Oct 2 2008, 16:16 GMT
by Kathy Lien

GFT

September non-farm payrolls are due for release on Friday and now more than ever the level of job losses could determine whether the Federal Reserve will cut interest rates this month and by how much. The US dollar hit a one year high against the Euro this morning, but has remained weak against the Japanese Yen. This divergent price behavior has been primarily due to the market's adjustment of ECB interest rate expectations. However should non-farm payrolls be particularly bad, it would suggest that the Fed could cut interest rates and cut them aggressively, triggering a turn in the EUR/USD that would make its price action more in line with the sell-off in USD/JPY.

Job Losses to Continue for Ninth Straight Month, NFPs Should Fall by More than 100k

For the first time in this cycle, the market is looking for non-farm payrolls to fall by more than 100k. This would mark the ninth consecutive month of job losses but it would not be the first time that non-farm payrolls have actually dropped by the psychologically hobbling 100k amount. In fact, we believe that non-farm payrolls could fall as much as 130 to 150k and even if it falls short of our forecasts, the market's price action reflects their expectations and everyone still expects the labor market to worsen. The 4 week average of jobless claims and continuing claims remain at 5 year highs. Claims are usually not subject to significant revision and are therefore very reliable leading indicators for NFP. Also, we have not heard the last of the layoff announcements. With market caps taking a bit hit and lending difficult to attain, US companies are tightening their belts and cutting back.

Of the 76 economists surveyed by Bloomberg, the most optimistic forecast is by Morgan Keegan & Company who calls for only a 13k drop in non-farm payrolls and the most pessimistic is Deutsche Bank who is calling for a 175k drop. Even though the US economy is not in an official recession, many people argue that the current problems are unprecedented. Therefore it is worthwhile to take a look at how bad things got for the labor market in prior recessions. Over the past 30 years, there have been 3 recessions and in each of those recessions, we have seen at least 11 consecutive months of job losses with at least one month where non-farm payrolls fell more than 300k. If this downturn is much worse than what we have seen since the Great Depression, we would not only expect job losses to continue into the end of the year but for the losses to grow.

However as pessimistic as we are, it is important to point out there are arguments for an improvement in non-farm payrolls:

Arguments for a More than 100k Drop in Non-Farm Payrolls

1. Employment component of Manufacturing Sector ISM Fell from 49.7 to 41.8
2. 4 Week Average Claims and Continuing Claims at 5 Year High
3. Challenger Layoffs Increased by 32.6%

Arguments for a Less than 100k Drop in Non-Farm Payrolls

1. Consumer Confidence Increases from 58.5 to 59.8
2. Monster.com Employment Index Increases from 159 to 160
3. ADP Reports -8k in Private Sector Payrolls
4. Strike Activity Decreased by 4200

Despite the turmoil in the financial markets, consumer confidence has improved, but the survey was closed before Monday's 777 point drop in the Dow. The Monster.com employment index and the ADP report also points to a smaller drop in payrolls, but the reliability of ADP is in question and unfortunately the most reliable leading indicator for non-farm payrolls, which is service sector ISM will not be released until after the NFP report. There is practically no chance that private sector payrolls only declined by 8k last month, especially since this would not be the first time that ADP has overestimated non-farm payrolls.

How Non-Farm Payrolls Will Impact the Fed's Decision and the EUR/USD

This time around, non-farm payrolls would determine 2 things – how much the Fed cuts interest rates and whether the EUR/USD will hit bottom. Here are the possible scenarios:

Payrolls Drop By 75k or Less: If payrolls is drop by less than 75k, the Federal Reserve may postpone their interest rate cut and even if they do not, the best that we will get out of the Federal Reserve is a quarter point rate cut accompanied by neutral comments. This would drive the EUR/USD towards 1.35 and help USD/JPY recover. 

Payrolls Between -76k to -125k: If payrolls are anywhere between -76k and -100k, the Federal Reserve will probably cut interest rates by 25bp and hint that more easing may be necessary. This would keep the dollar under pressure against the Japanese Yen but it may not stop the EUR/USD from falling. 

Payrolls Drop by More -125k: If payrolls drop more than -125k, there would be a strong case for either an intermeeting rate cut by the Federal Reserve or a 50bp cut at their scheduled meeting on October 29. As of 11:30am ET today, Fed Fund futures are pricing in a 90 percent chance of a 50bp rate cut in October and 10 percent chance of a quarter point cut (Fed fund futures can be very volatile). This would mean a bottom for the EUR/USD and further losses in USD/JPY. 

The recent improvement in inflationary pressures makes it easier for the Federal Reserve to cut interest rates. The dovish comments by European Central Bank President Trichet today suggests that if the expected approval of the bailout plan the House fails to stabilize the markets, there could be coordinated easing by the ECB and Federal Reserve, which would be first in 7 years.

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Published on  Thu, Oct 2 2008, 16:29 GMT