It has been a mixed day in the currency markets with the U.S. dollar trading lower against the euro, Australian and New Zealand dollars but higher against the British pound, Japanese Yen and Canadian dollar. Stocks were unchanged for most of the day but in the last half hour of trading, they plummeted as traders took profits ahead of Friday’s non-farm payrolls report (NFP). Consolidative price action is not uncommon before NFP, which is the most market moving event risk for the currency market because the labor market is the backbone of the U.S. economy and jobs are critical to the U.S. recovery. The price action even suggests that traders are in denial about the sharp decline in non-manufacturing ISM because they are holding onto the hope that job losses are receding.
How Significant is the Decline in Service Sector ISM?
However the non-manufacturing ISM report is very important because the service sector accounts for almost 90 percent of the U.S. economy. The drop from 50.6 in October to 48.7 in November propels the sector back into contractionary territory. Although this is discouraging, it is not completely surprising since the pace of recovery in the U.S. economy has slowed. Also, during the 2001 recession, the service sector oscillated in between expansionary and contractionary conditions. Yet the details of the report were not nearly as discouraging as the headline release. There was only a modest decline in new orders and actually an increase in export orders and a slower contraction in employment. At this point, the manufacturing sector is outperforming the service sector thanks to a weaker dollar but if the financial sector continues to improve, the service sector could catch up. The non-manufacturing ISM report is a fairly important barometer of the overall U.S. economy but its most practical usage is to help predict the directional move in non-farm payrolls. In our November Non-Farm Payrolls Preview , we included a chart illustrating the strong correlation between the employment component of service sector ISM and NFP - the 0.5 increase in the employment component signals only a marginal improvement in the payrolls report.
What to Expect from Non-Farm Payrolls
The bar is set high for Friday’s non-farm payrolls report as the market expects the smallest amount of job losses in 25 months. The consensus forecast calls for non-farm payrolls to fall by 125k, but actual economist forecasts range anywhere from -30k to -185k. Of the 9 leading indicators of non-farm payrolls that we typically follow, 7 point to a strong number. However 3 of the most important (service ISM, ADP and Consumer Confidence) only rose modestly which is why we believe that the improvement in payrolls could be small. In fact, we would not be surprised if non-farm payrolls fell by more than 150k in the month of November because the only unambiguously positive improvement was in jobless claims. This means that as usual, the only thing that we can be certain of when it comes to the market’s reaction to NFP is volatility because given the wide range of forecasts someone is bound to be surprised. The jobless rate will also be important now that it has breached the 10 percent mark because if it falls, everyone will begin to wonder if unemployment has finally peaked. Read our NFP Preview for more on How the EUR/USD could react to Non-Farm Payrolls.
How do Obama, Geithner and Bernanke Feel?
On the eve of the jobs report, President Obama held a Jobs Summit. Conspiracy theorists may wonder if this is damage control before an ugly number is released but we won’t speculate on that because the goal of the Summit is to let America know that job creation is a top priority for the Obama Administration. He called on the nation’s largest companies to “bring their A-game” in presenting new ideas for job creation. In an interview with CNBC, Treasury Secretary Geithner echoed Obama’s commitment to job creation. He also indicated that it is vital to bring down the U.S. budget deficit and for the government to persuade the world that it will be more fiscally responsible in the future. In his confirmation hearing, Federal Reserve Chairman Ben Bernanke defended the Fed’s role in bailing out financial firms and indicated that their job is far from complete. He has received a lot of criticism and if he not confirmed by the Senate Banking Committee for a second term as the head of the central bank, expect the U.S. dollar to sell off aggressively.
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