Research Note: January NFP Prep

February 5, 2016

The January Non-Farm Payroll report will be released tomorrow at 8:30 EST (13:30 GMT) with expectations centered on a headline print of 192k after last month’s stellar 292k reading. My model suggests that the report could miss even these subdued expectations, with leading indicators suggesting a January headline NFP reading of 160K.

The model has been historically reliable, showing a correlation coefficient of 0.90 with the unrevised NFP headline figure dating back to 2001 (1.0 would show a perfect 100% correlation). As always, readers should note that past results are not necessarily indicative of future results.

Compared to last month, the leading indicators for the non-farm payrolls report all deteriorated notably. The ISM Non-Manufacturing PMI Employment, long a source of strength in the US labor market, fell by nearly 4 points to 52.1% this month, while the Manufacturing PMI employment component fell deeper into contraction territory at 45.9. Adding insult to injury, both the ADP employment report (205k from 257k last month) and Initial Jobless Claims (up to 294k in the survey week from 267k last month) weakened as well.

Trading Implications

After the Federal Reserve raised interest rates in December, many analysts assumed it would mark the beginning of a prolonged interest rate hike cycle. In the seven weeks since then though, the market’s expectations have seen a dramatic dovish shift. As of writing, Fed Funds futures traders are pricing in only a 38% probability of a rate hike at all in 2016, according to the CME’s FedWatch tool, and a disappointing reading could prompt those odds (and by extension, the US dollar) to fall further.

As always, traders should monitor both the overall quantity of jobs created as well as the quality of those jobs. To that end, the change in average hourly earnings could be just as critical as the headline jobs figure, especially with many FOMC voters looking for signs of inflation on the horizon before raising interest rates. Wages were flat month-over-month in December’s jobs report, so dollar bulls will want to see growth return before declaring the report as strong, regardless of the total number of jobs created.

Historically, USD/JPY has one of the most reliable reactions to payrolls data, so traders with a strong bias on the outcome of the report may want to consider trading that pair.

Though this type of model can provide an objective, data-driven forecast for the NFP report, experienced traders know that the U.S. labor market is notoriously difficult to predict and that all forecasts should be taken with a grain of salt. As always, tomorrow’s report may come in far above or below my model’s projection, so it’s absolutely essential to use stop losses and proper risk management in case we see an unexpected move. Finally, readers should note that stop loss orders may not necessarily limit losses in fast-moving markets.

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