With Q1 U.S. GDP contracting by 0.7%, is a rate hike still the way to go? Perhaps the upcoming non-farm payroll (NFP) employment report can shed some light on that, as it could give forex traders more clues on the overall direction and health of the economy.
What is this report all about?
To all the newbie forex traders out there, the NFP employment report is usually one of THE major market movers for the Greenback. This report quantifies various labor indicators in all sectors during the reporting period, with the exception of the farming industry, the general government, and some non-profit organizations. Workers employed by private households (e.g. Alfred, Batman’s awesome butler) are also not included. Aside from the number of jobs created (or lost) during the reporting period, other labor indicators in the report that most forex traders pay attention to are: the (1) jobless rate and the (2) average hourly earnings.
The NFP report is very important because it provides a snapshot of the overall health of the labor market. And a healthy labor market usually leads to higher consumer confidence and consumer spending, not to mention higher overall economic output. Think of it this way: if more people have jobs and they see that other people have jobs, then they’ll feel confident about the economy and begin buying and spending more. As the buying and spending intensifies, companies will need to increase production and hiring in order to meet demand, causing the economy to expand. Of course, as demand increases, so too will prices (i.e. inflation). And higher inflation levels generally leads to high interest rates. Pretty simple, huh?
What happened last time?
The May 8 release showed that non-farm employment change was slightly below expectations at 223K new jobs, but it was still significantly better than the previous reading, which was revised downward from 126K to 85K. April’s jobless rate also slid down by 0.1% to 5.4% as expected, the lowest since May 2008. Even better, the labor force participation rate slightly went up by 0.1% to 62.8%. But average hourly earnings was disappointing since April posted a mere 0.1% increase against the expectation that it will remain flat at 0.2%. This was attributed to an increase in part-time jobs since part-time workers usually get paid less.
On a more interesting note, the non-farm employment change estimate provided by Automatic Data Processing, Inc. (ADP) was quite off the mark since it showed a job increase of only 169K (199K expected, 175K previous). The ADP estimate usually acts as a leading indicator for the government’s own reading because ADP is a major payroll services provider to over 610,000 businesses, including multinational corporations.
What is expected by most forex traders?
Most forex traders expect that non-farm employment change will show a slight uptick from 223K to 225K new jobs while the jobless rate is expected to remain flat at 5.4%. The average hourly earnings, meanwhile, is expected to increase from 0.1% to 0.2%. As for the most recent ADP release, the actual reading was 201K new jobs, slightly above the expected 200K, and a significant improvement over the previous reading which was downgraded to 165K from 169K. But it’s difficult to say whether or not ADP will miss the mark again. Weekly initial claims doesn’t really provide any insight either since they’ve been roughly within the 270K range, although that could also mean that the jobless rate may remain flat as expected.
Do note that many forex traders may be paying close attention to average hourly earnings ever since Fed Vice Chairman Stanley Fischer stated that there “are signs of wages beginning to rise in a variety of places.”
How could the Greenback react?
The ADP’s estimate is usually used as a leading indicator for the government’s own estimate. As such, forex traders were expecting dismal results, so it’s quite understandable why the market hesitated when the government’s NFP reading was within expectations.
The dollar only weakened by a mere 60 pips versus the yen (much less against other currencies) when the report was released.
Compare that with the 110-pip drop when the the ADP reading for March was significantly worse-than-expected in tandem with the government’s own reading.
So what can we expect? Well, as already stated, if ADP and NFP conflict, then the market also becomes conflicted. But if they are in tandem, then the market usually moves hard and fast. The weekly initial claims are also hinting that the jobless rate will hold as expected while Fed officials are confident that wage growth will increase, so forex traders should expect some volatility if the actual readings are way off the mark.
Do keep in mind that prelim Q1 2015 GDP contracted by 0.7%, which doesn’t really help create optimism for a future rate hike, although the Fed did emphasize that it’s only “transitory” and that a rebound may come in sooner or later. They even reiterated this in the latest FOMC statement. All I’m saying is that if the actual readings disappoint, then forex traders can expect the Greenback to fall down hard. But if not, see ya at the top!