How Will Non-Farm Payrolls Impact the Dollar?

The U.S. non-farm payrolls report is one of the most important pieces of data scheduled for release this week and it will play a major role in shaping expectations for Wednesday's Federal Reserve meeting.  While the U.S. dollar traded higher against most of the major currencies today, its cautious rally over the past week particularly against the Japanese Yen is a sign of the market's lack of confidence in tomorrow's report.  The Fed is widely expected to raise interest rates and the real question is where they go from there.  Will Janet Yellen keep the Fed on a tightening track, hinting of further moves to come or will she take a step back and leave Powell with a clean slate?  That's what investors will be thinking about after they see Friday's jobs report.  Strong job growth accompanied by a solid increase in wages could go a long way in boosting expectations for 2018 tightening.  Modest job growth accompanied by a subdued wage gains will keep investors skeptical of Yellen's intentions. Either way as this is the final NFP report before this year's last Federal Reserve meeting it will undoubtedly have a significant impact on the greenback.

Unfortunately, when it comes to this month's jobs report, the risk of miss is greater than the possibility of a beat which means the dollar could give up its gains at the end of the week.  Economists are looking for job growth to slow to 195K from 261K in November which is not a big deal considering that anything close to 200K is a strong number.  However job growth could be significantly lower than 200K according to some other labor market indicators.  In particular, ADP reported weaker private payroll growth, job growth slowed according to the manufacturing and non-manufacturing ISM reports, Challenger reported a sharp rise in layoffs, the 4 week average of jobless claims increased and the same is true for continuing claims.  The only argument in favor of stronger job growth is the consumer confidence index, which ticked higher but improvement was countered by the University of Michigan's report that sentiment declined.  Yet the pace of average hourly earnings growth and the unemployment rate will be what matters the most on Friday. If wage growth slows and the unemployment rate ticks up, it will offset any healthy payroll rise.  By the same token, if job growth is between 150K and 200K but average hourly earnings meet the market's 0.3% forecast and the unemployment rate holds steady at 4.1%, the dollar could recover any initial decline quickly to end the day higher.  The recent consolidation in USD/JPY means that pair will be particularly sensitive to the outcome of tomorrow's report.

Here's a look at how the arguments for stronger vs. weaker November payrolls report stack up:

Arguments in Favor of Stronger Payrolls

1. Consumer Confidence Index Rises to 129.5 from 126.2

Arguments in Favor of Weaker Payrolls

1. ADP Drops to 190K from 235K

2. Employment Component of Non-Manufacturing ISM drops to 55.3 from 57.5

3. Employment Component of Manufacturing ISM Drops to 59.7 from 59.8

4. University of Michigan Consumer Sentiment Index Tumbles to 98.5 from 100.7

5. Challenger Reports 30% Rise in Layoffs in November

6. 4 Week Average Jobless Claims Rises to 241.5K from 232K

7. Continuing Claims Rises to 1.908M from 1.868M

With the EU's 48-hour Brexit deal deadline looming, it should be no surprise that sterling experienced the greatest intraday volatility today.  At the very start of the NY session GBP/USD, which had been trading above 1.34 U-turned and dropped 100 pips in less than hour. It then stabilized and within that same time frame rebounded approximately 80 pips and eventually ended the day in positive territory.  There was very little rhyme or reason to this rollercoaster ride, which was sparked by nothing more than rumors and hope.  Investors are worried that the UK will not be able to meet the EU's pre-Summit deadline but as talks with the DUP continue, they are still hopeful. Calling this a tricky situation is an understatement and while the European Commission said today that the final deadline could be as late as Sunday, Prime Minister May will be racing against the clock. Unless a deal is announced on Friday, we expect sterling to resume its slide as investors square up before the weekend.  

Although the euro ended the day unchanged against the greenback, 5 days have past since we've seen a meaningful rally in the single currency. An unexpected fall in German industrial production contributed to EUR/USD's underperformance.  With the currency pair finding its way below the 20 and 100-day SMA, we could foresee a move down to 1.1750 before tomorrow's NFP release.  We don't expect much help from Germany's trade and current account surpluses, which are expected to have shrunk in October. After that, the EUR/USD's direction will be determined exclusively by the market's reaction to the U.S. jobs report so there's scope for an upside or downside move depending on the outcome.

All 3 of the commodity currencies traded lower against the greenback today with the Australian dollar slipping to its weakest level since June. AUD extended its losses after a disappointing trade balance report. According to our colleague Boris Schlossberg, the data fell woefully short of expectations coming in at 0.1B versus 1.4B eyed. The sharp falloff in exports indicates that demand from China may be tapering and that does not bode well for the unit long term." The New Zealand dollar followed the Australian dollar lower and looking ahead, China's November trade balance report could have a significant impact on both currencies. Despite higher oil prices, a decline in the IVEY PMI index and sharp rise in Canadian building permits, USD/CAD extended Wednesday's post Bank of Canada gains.