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US non-farm payrolls playbook: It’s all about clarity

The market has debated when the Fed will hike the fed funds rate for many months and any adjustment in monetary policy carries huge implication for the US and emerging-market economies. What we really need is certainty. Will that come tonight?

Non-farm payrolls
Source: Bloomberg

With interest rate markets currently pricing in a 30% probability of a September hike in interest rates from the Federal Reserve, 42% for October and 57% for December, tonight’s US non-farm payrolls report (22:30 AEST) provides an important piece of the economic jigsaw.

Keep in mind Richmond Fed member Jeffrey Lacker (voter) speaks 20 minutes before the jobs data. His speech is titled ‘the case against further delay’.

What are the expectations?

The market consensus is that we’ll see 218,000 jobs created, with economists’ estimates ranging from 253,000 to 120,000. The unemployment rate is expected to tick down to 5.2%, moving into the Fed’s full employment target.

Average hourly earnings (yoy) are expected to increase a modest 2.1%. The U6 unemployment rate (the broadest measure of employment) fell to 10.4% in July – the lowest level since July 2008. This needs to be watched.

The traditional leading indicators suggest a robust jobs print tonight, with the August ADP private payrolls coming in at 190,000, while the employment sub-component index of the services ISM shows 56.0.

My simplified playbook:

If there are 250,000+ jobs created

This is clearly the best result all round. On this result, US bond yields push aggressively higher, in turn putting a strong bid into the USD. Emerging-market assets will likely be sold aggressively (I specifically like long positions in USD/BRL).

A point of contention is whether US equities would rally given that we should see the implied probability of a near-term increase in the fed funds rate.

My view is a 250,000+ print would provide increased clarity around Fed policy and this should prove to be a strong positive for US equities, although others will argue against this view.

I would also look at spikes in implied volatility. Being long volatility index futures would work well in this environment.

If 165,000 to 180,000 jobs are created

This is a grey area and the scenario I feel would actually prove to be the worst case for market participants. If you are an economist who has September or October pencilled in for Fed rate hikes then you probably wouldn’t amend that view, but the growth in job creation is lacklustre and would provide the least amount of clarity. I would personally expect a modest sell-off in the USD, with USD/JPY likely to push back into the ¥119.50 area.

US equities would not know where to turn, but I suspect traders would focus much more closely on the unemployment rate or hourly earnings and drill into the report for inspiration.

150,000 and under

Clearly the 30% probability already priced into the September meeting would be reversed and would mean strong buying in US treasuries across the curve. It would mean a much weaker USD and, given the extended nature of AUD short positions (held by leveraged funds), I would look for a move in AUD/USD into $0.7150 to $0.7200.

Emerging-market currencies would rally aggressively given how unloved they are at present. US equities would likely sell off, although again there are some who feel the opposite is true and we would get a stimulus-invoked rally. Given global growth has been a concern for investors and traders, I suspect these risks will resurface and US equities will be sold.

Final thoughts

Keep in mind that August is traditionally a poor month of job creation relative to expectations. As Deutsche points out, August employment has missed consensus in 21 out of the last 27 years. More recently, the last four Augusts have missed consensus by a sizeable 55,000.

As they say, past behaviour doesn't predict future performance. However, if the seasonal weakness continues, I struggle to see how the Fed could move rates not only in September, but at any time in 2015.

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