NFP preview: Expectations are high, but will NFP disappoint?

The US labour market data for September will be released on Friday 5th October at 1330 BST. The market’s official expectation is for a headline Non Farm Payroll figure of 185k for September, down from August’s reading of 201k. However, with a recent spate of spectacular economic data out of the US, and positive sentiment emanating from the Federal Reserve, Chair Jerome Powell called the US economic data “remarkably positive” in recent comments, expectations for this labour market report are sky high.

US economic data shine

To put this report into context: US weekly jobless claims are at their lowest level since 1969, ADP private sector employment recorded its fastest pace of growth for 7 months, and the ISM non-manufacturing survey rose at its fastest pace for a decade, and included a strong jobs component. The NFP is a crucial piece of this jigsaw. The market is already discounting the prospect of a strong report: the dollar has strengthened ahead of Friday’s data release: USD/JPY broke through 114.00, while EUR/USD is back below 1.15. The 10-year Treasury yield broke through the crucial 3% barrier this week, and yields rose at one of their fastest paces since Trump won the US Presidency. This suggests to us that the market is expecting a bumper NFP on Friday, which also means that the risk of disappointment is strong.

A disappointing report and the USD:

Anything less than 185k, the official economists’ expectation for NFPs, could trigger sharp dollar selling and treasuries could rally, yields fall, on the back of a weaker than expected report. It is also worth looking at the wage component, which is arguably the most important part of this data release. The market is expecting wage growth to rise 0.3% last month, down from 0.4% growth in September. This would push the annual rate of wage growth down a notch to 2.8% from 2.9%. If wages slip, then this could heighten dollar selling.

An interesting dilemma for traders would be if the headline NFP number is below 200k, yet the wage component is stronger than expected. In this scenario we would expect there to be an initial knee-jerk reaction lower in the buck, before the dollar heads higher in the long term. This is because wage data is a key element of the US inflation picture. Higher wage growth is the “right” kind of inflation for the US economy and is something the Fed wants to see before it contemplates raising interest rates in December. Strong wages suggest stronger consumption down the line, driving demand-driven inflation rather than inflation that comes from external sources, such as rising oil prices. Wage data also correlates closely with core inflation, thus a stronger than expected reading for US wages on Friday could trigger further upside in the US Treasury yield, which is dollar positive.

It is worth noting that a rising yield is likely to be negative for EM FX and also for US stocks, which have slipped today on the back of worries about rising US borrowing costs.

The NFP and the Fed

The market is currently pricing in an 82% chance of a rate hike to 2.25% – 2.50% in December. This is up from a 70% chance last week. Interestingly, the prospect of a rate hike to 2.5 – 2.75% in March 2019 has risen sharply this week, and is now above 50%. A strong labour market report on Friday would likely push up expectations for 2019 rate hikes, which may lead to a long term positive glow on the USD and US Treasury yields on the back of this report, as long as payrolls are extremely strong.

The question ahead of the labour market report is ‘can the labour market report deliver the goods for a market that is bullish the US dollar?’ Also, how much of the good news is already priced in? The strong rally in the USD and the sharp rise in US Treasury yields is already a sign that the market is expecting a bumper NFP. Thus, the market may be difficult to please on Friday, and the risk of a disappointment and a short-term dollar sell off are rising.

Whatever the US labour market report delivers tomorrow, USD/JPY is typically the most highly correlated FX pair to the NFP report, and is worth watching closely in the aftermath of the release.