Will Non-Farm Payrolls Make or Break the Dollar?

Throughout this past week we have expressed our skepticism about the U.S. dollar's rally.  Investors were hoping for a major tax reform announcement from President Trump (that didn't happen) and were satisfied with the Administration's relatively benign response to North Korea's missile launches.  However NK hasn't officially backed down and the Trump Administration has gone ahead and escalated tensions with Russia by ordering the closure of 3 Russian diplomatic facilities in the U.S.  So unfortunately geopolitical tensions, the debt ceiling debacle and uneven U.S. data continue to plague the currency.  After racing higher before the start of the North American trading session, the dollar nosedived on the back of today's economic reports.  Challenger reported an increase in layoffs, jobless claims rose slightly, personal income growth accelerated but personal spending growth missed expectations.  The PCE deflator also rose 0.1%, which was stronger than the previous month but not enough to boost the year over year deflator growth rate. In other words, the data shows that inflation remains subdued. Pending home sales declined and while the Chicago PMI index beat expectations it was slower growth than the previous month.  In a nutshell these reports were not strong enough to sustain the dollar's rally.

Looking ahead, non-farm payrolls could make or break the dollar because it's the last NFP release before the Fed meets next month.  When it comes to this report, the ONLY question that matters is whether job and wage growth is strong enough for the Federal Reserve to raise interest rates at the end of the year.  Even though the Fed doesn't need to make a decision now. There are 3 more months and 3 Non-Farm payroll reports before the December rate decision, but investors are desperate for something to validate the dollar's recent rally.  And if Friday's jobs report fails to impress, we could see EUR/USD back at 1.20 and USD/JPY at 109.00.  Taking a look at some of the "leading indicators" for non-farm payrolls, nearly ALL support the case for stronger job growth. However the single most important report (non-manufacturing ISM) will not be released until next week so we won't be able to use that as a guide.  But job growth and wage growth in July were very strong, leading economists to look for softer numbers all around.  If NFPs simply "meet" expectations, it won't be enough to revive the rally in the U.S. dollar.

Payroll growth needs to exceed 200K (with no downward revisions to the July report) AND wages need to grow by 0.3% or more for investors to believe that Fed Chair Yellen won't provide much guidance beyond taking the first steps to unwind their balance sheet next month.  If we see that, USD/JPY could make its way above 111.00.  However if wage AND job growth fall short, USD/JPY could drop back to 109.00 and possibly even lower.

September Non-Farm Payroll Preview

Arguments for Stronger Payrolls

1. ADP Employment Change at 237K - Strongest Level in 5 Months 

2. Consumer Confidence Index Hits 2nd Highest Level Since 2000

3. University of Michigan Index Hits Highest Since Jan

4. 4 Week Average Jobless Claims Drops to 236K from 242K

5. Continuing Claims Drops to 1.94M from 1.956M

Arguments for Weaker Payrolls 

1. Challenger Reports 5.1% Increase in Layoffs 

The other big story today is Canada and its exceedingly strong GDP report. Canada's economy expanded by 0.3% in June, lifting the annualized quarterly GDP growth rate to 4.5% from 3.7%, the strongest pace of growth since 2011.  At this pace, the Bank of Canada will have to raise interest rates again this year as Canada is the fastest growing G7 nation.  Some economists are even looking for a hike next week.  Oil prices jumped 2.5% today, adding fuel to the currency's rally.  USD/CAD erased all of yesterday's gains and is headed for fresh 2 year lows below 1.2400.  The Australian dollar also recovered all of its earlier losses and turned positive on the day but the New Zealand dollar was left behind even though it bounced off its lows.  Private capital expenditure was much stronger than expected in the second quarter - a sign of strength for the business sector.  Australia's manufacturing PMI report is scheduled for release this evening and this increase bodes well for the report. Today's move in AUD/USD puts 80 cents back in sight.  The New Zealand dollar on the other continues to be pressured by softer data and the Reserve Bank's cautious views.  ANZ reported lower activity and business confidence for the month of August as house price growth slowed to 4.8% from 6.4% according to QV. AUD/NZD burst above 1.10 in response and the next stop could be 1.12.

The euro ended the day flat after venturing down to a low of 1.1823 during the early North American trading session.  Although German retail sales fell 2 times more than expected and German unemployment data was pretty much unchanged from the previous month, the Eurozone's August inflation estimate jumped to 1.5% from 1.3%.  Inflation is on the rise and that will be positive for the euro going into next week's ECB meeting.  If tomorrow's U.S. labor market report fails to live up to expectations, we expect to see EUR/USD trade back to 1.20.  Sterling also erased earlier gains to end the day steady versus the greenback.  Tomorrow is an important day for GBP with UK manufacturing PMI numbers scheduled for release. Given the strength of the CBI index, we are looking for a strong release that should extend GBP/USD's gains ahead of non-farm payrolls.  We could easily see GBP/USD trade up to 1.2960 before NFPs.