NFP: Here’s Why Dollar Bulls Should Worry

By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.

• 4 Reasons for Dollar Bulls to be Cautious about Payrolls
• GBP Crashes as BoE Disappoints
• USD/CAD Consolidates Ahead of Dual Employment Reports
• AUD: Disappointing Employment Numbers
• NZD: Oil Below $45, Gold Up
• Euro Rises on Data and EUR/GBP Short Covering

4 Reasons for Dollar Bulls to be Cautious about Payrolls

For the financial markets, the U.S. Non-Farm payrolls report is generally one of the most market-moving pieces of economic data. Even though many traders are off for their August holidays, this month's labor-market numbers will receive more attention than usual after the Federal Reserve singled out jobs as its area of focus. At the last FOMC meeting the Fed said rates will rise after "some further" job-market improvement and for liftoff to begin in September, we need to see strong job growth in the next 2 employment reports. More specifically this mean that job growth needs to exceed 215K in July and August with the unemployment rate holding steady at 5.3% or improving during this period. Average hourly earnings also need to grow at a steady pace. Right now economists are looking for all of these conditions to be met. But with so many different components, there's always the chance that one of the line items will miss. In fact, even though the dollar is trading well, a strong labor-market report is not a done deal. Every month we compile a list of leading indicators for nonfarm payrolls to gauge how well the economy or labor market is doing and this month there are 4 reasons for dollar bulls to be cautious about payrolls. Challenger Grey & Christmas reported a 125% increase in layoffs. ADP reported a smaller increase in private-sector jobs and according to both the University of Michigan and the Conference Board, consumer sentiment deteriorated in July. However there is also reason to be optimistic. Not only have jobless claims been very low but most importantly the increase in the employment component of service sector PMI was the largest ever. We believe that payroll growth will exceed 200k, but given the following breakdown and USD/JPY finding resistance below 125, we are weary of a miss.

Leading Indicators for July Non-Farm Payrolls

Arguments in Favor of Stronger Payrolls

1. Employment Component of ISM Non-Manufacturing Rises by Record Level
2. Employment Component of ISM Manufacturing Rises
3. 4-Week Average Jobless Claims Drops to 268K
4. Continuing Claims Decline

Arguments in Favor of Weaker Payrolls

1. Challenger Reports 125.4% Rise in Layoffs
2. ADP Employment Change Drops to 185K from 229K
3. Sharp Drop in University of Michigan Consumer Sentiment Index
4. Sharp Drop in Consumer Confidence Index

GBP Crashes as BoE Disappoints

Sterling traded lower against all of the major currencies today after the Bank of England monetary policy announcement failed to impress. Investors were looking for a clear sign that the central bank is moving closer to raising interest rates but instead what they got were changes in their economic forecasts that suggests the central bank is still in no rush to tighten. The Bank of England left monetary policy unchanged with only 1 member of the policy committee voting for a rate rise. Investors had been looking for up to 3 dissents but McCafferty was the lone hawk. More importantly, the BoE lowered its 2015 and 2016 inflation forecast citing lower commodity prices and a stronger currency. They indicated that pound strength is a downside risk to near-term inflation and could offset the export boost from stronger global growth. While they upgraded their 2015 GDP and wage forecasts, these changes were not enough to sustain the gains in the currency. Even BoE Governor Mark Carney's comments at the accompanying testimony sounded more balanced. He indicated that the central bank is watching the pound rate carefully. It hasn't removed the need for gradual rate increases but its potential pass through to CPI is having an influence on policy. Clearly inflation is not where the BoE wants it to be for rates to rise and according to Carney "negative inflation wouldn't be surprising." The BoE is still on track to raise interest rates in 2016 but Thursday was clearly about increasing transparency and not signaling a future change in monetary policy.

USD/CAD Consolidates Ahead of Dual Employment Reports

The price of oil closed below $45 a barrel for the first time since March 19. Normally this would have driven the Canadian dollar to fresh multiyear lows versus the greenback but with dual employment reports scheduled for release on Friday -- employment change and the unemployment rate -- investors are treading cautiously and limiting new positions in USD/CAD. The 600-pip rally in the currency pair over the last month took USD/CAD into overbought territory and even though there's no major resistance until 1.35, investors need to see positive U.S. and/or negative Canadian employment numbers to allow the currency pair to move higher. While economists are looking for strong U.S. jobs data, they are also looking for better Canadian data -- so the performance of the pair hinges on the greater surprise. The IVEY PMI report is also scheduled for release and another big nose dive is expected in the month of July. Meanwhile the Australian dollar held steady and the New Zealand dollar traded higher. No economic reports were released from New Zealand but investors were not impressed by Wednesday night's Australian employment report. Even though job growth beat expectations (38K vs. 10K forecast) and the participation rate increased, the majority of job growth was part time and the unemployment rate rose to 6.3%, the highest level since January. Looking ahead, we do not expect Australia's PMI Construction report, which was due out Thursday evening, to have a significant impact on the Australian dollar.

Euro Rises on Data and EUR/GBP Short Covering

Profit taking ahead of U.S. nonfarm payrolls drove the euro higher against the dollar. Demand for the single currency was also supported by EUR/GBP short covering and Eurozone data. German factory orders rose 2% in June, driving the year-over-year gain to 7.2%, the strongest since November 2013. The weaker euro and lower oil prices are clearly having a positive impact on the Eurozone's largest economy and we are also seeing that strength in the retail PMI reports. According to Markit Economics, consumer consumption in the region accelerated in July with gains seen in both Germany and France. Although German Industrial Production and Trade Balance reports are scheduled for release Friday, the performance of EUR/USD will be determined by U.S. data.