On The USD Reaction To Tomorrow's Payroll Report
The new-normal bizarro world in which we live and trade requires a new set of un-common-sensical thinking to succeed. As we noted earlier, perception is far more important than reality (at least in the short- to medium-term), and tomorrow's payroll report could well be the most egregious example of this yet. Citi's Steven Englander agrees, noting that it seems very possible that the focus will be on the unemployment rate (UR), because of its political importance, rather than the non-farm-payroll (NFP) change, despite its greater economic importance. Given the high correlation to equity (risk) price movements and the focus of market movements likely being driven by the unemployment rate - the question becomes to what degree political factors will offset the negatives typically associated with economic slowing - and what the USD reaction will be to various ranges of NFP and UR.
Via Steve Englander, Citi:
Tomorrow’s payrolls may be the most important economic release until the election. It seems very possible to us that the focus will be on the UR because of its political importance, rather than NFP, despite its economic importance. Many analysts feel that a Republican Presidential victory will be better for the asset markets, at least in the short term. There is some room for debate on this, but it is probably the consensus working assumption.
Our conclusion is that the UR may be a more important driver of FX market reactions on Friday than payrolls, and that the most risk positive/USD negative outcome is a run-up in the unemployment rate, accompanied by a strong payrolls print, essentially the opposite of last month’s release.
There is one more release on Nov 2, but tomorrow’s may set the tone of the next month of campaigning and be the more important.
Citi’s NFP forecast is very close to that of the market, Citi 110k, consensus 115k. Of 92 forecasts reported on Bloomberg, 87 are in the 85k -145k range, which is a very tight range by historical standards (and no indication that there is less uncertainty about the outcome.)
One unusual uncertainty is how the election cycle will affect the reaction to payrolls. A run-up in the unemployment rate will be negatives for President Obama’s re-election chances, since the UR gets the most political attention.
It is very likely that a weak print tomorrow will be less negative for risk than it would be in December, because of the election factor. Unlike last month, immediate Fed policy is not in play so it seems likely that, absent the political cycle, market reaction to a payrolls surprises would be in the cigar is just a cigar category – a strong outcome is risk positive and USD negative and a weak outcome is risk negative and USD positive, (Some would question this risk-on/USD-off correlation but it has been broadly in place since 2008 and more recently since May of this year, as the chart at the top clearly indicates).
The question is whether the degree to which political factors would offset the negatives typically associated with economic slowing. Since the indications are that an Obama victory is still the more likely outcome, despite last night’s debate and subsequent narrowing in some election indicators, the bigger FX market reaction may be to bad numbers that are seen as further evening out the odds between Obama and Romney, rather than a strong outcome that restores the skew in Obama’s favor.
UR Estimates (prior 8.1%)
So we could be in a situation where the USD reactions from most USD negative (i.e. most risk-on) to most USD positive (most risk-off) are:
- Payrolls above 150k and the UR rising.
- Payrolls between 100k and 150k and the UR rising
- Payrolls below 100k and the UR rising
- Payrolls above 150k and the UR falling
- Payrolls between 100k and 150k and the UR falling
- Payrolls below 100k and the UR falling
In the above we are giving the unemployment rate a lot of weight.
It is possible that investors are sufficiently worried about growth that they will not look past a strong payrolls outcome, and simply breathe a sigh of relief and buy risk if strong payrolls and a falling UR are the outcome.
The tradeoff between the headline unemployment rate and headline payrolls may also not be as canonical as we make it out, so that market reaction to 4), for example, may be more positive than to 3) or even 2).
Finally, we are assuming that good news for the US is bad news for the USD. Some would question this assumption but this correlation remains broadly in place.