Non-farm payrolls look ahead

The ADP private payroll report is not a perfect predictor of the non-farm report. However, there is still a correlation between the two, and Wednesday’s 263,000 reading, well above the 185,000 expected, sends a message that Friday could see a similarly strong number. The non-farm report also looks at other elements, such as the participation rate (the percentage of active workers in the US), and, more crucially, average hourly earnings. With the US economy at 4.7% unemployment, the chances of a really big upside surprise on the jobs number is limited, but wage growth is still not as strong as many would like. As a result, the wage number is also very important, and could arguably have an equally strong impact. Friday’s report is expected to show the following:

A particularly strong reading on jobs and/or wages could push the US dollar higher, which would spell weakness for key pairs such as GBP/USD, EUR/USD and AUD/USD, and potentially see a rally in USD/JPY. This year US stock markets have generally risen in tandem with the dollar, so increased optimism surrounding the American economy could push the S&P 500 and others higher.

However, non-farm payrolls are just the beginning of a key month. The Federal Reserve minutes this week were not too revealing on the topic of other rate increases this year, except the information that it still aims to raise rates twice more. Of far more importance has been the news that the committee discussed beginning the long process of shrinking its balance sheet. While active quantitative easing (QE) has ended, the proceeds have been reinvested to maintain the balance sheet at its current size of around $4.5 trillion. This shrinking could cause long-term rates to rise, potentially undermining some of the economic recovery.

There is more discussion to come at the May meeting, but the market has clearly begun to fret that the Fed will have to work hard to find a way to run down its holdings without creating too much disruption. Investors have got used to a world where everything is underpinned by the Fed, and it will take time for that to change. The market reaction was negative, with US indices giving up gains and moving lower, so for now we may see the beginning of a more sustained pullback.

Finally we have earnings season to look forward to. Despite the worries of the past year and the uncertainties of this one, overall earnings are expected to rise around 10%. Indeed, we can expect that figure to be bettered, as actual earnings beat forecasts in each of the previous 20 quarters, by an average of 3.7%. With the market having rallied so strongly over the past six months, it might be tough for the market to justify current valuations even if earnings improve, but overall the trend for US companies remains encouraging.