It's Payrolls Friday!

 Happy Payrolls Friday everyone! I had hoped to do this briefing on a livestream on YouTube but I didn't think far enough ahead to set up my account, so just the blog post this month. 

In the post below I'll walk you through the consensus estimates, some things to bear in mind and also some possible trades off the back of the payrolls report (although I stress, I would not enter any of these trades before the report hits the wires. 

A quick primer: 

The Nonfarm Payrolls report is released monthly and contains a whole host of data about the labour market in the US. In normal circumstances, it would be a big market mover but since COVID hit moves have been a bit more muted. It's closely watched as it is a guide to Fed policy - if the labour market is strong and inflation high (like it is now), the Fed is likely to taper (reduce) its monthly asset purchases. If the labour market is weak, they are more likely to remain on hold with their current trajectory until "substantial further progress" has been made. Millions fewer Americans are working now than before the pandemic, so it is likely we need to see a strong number from the report for the Fed to announce tapering at its next policy meeting later this month. 

Generally, people are expecting that if a strong labour market print comes through today, the Federal Reserve will announce its timeline for reducing its asset purchases (in laymen's terms, brrrrrrrr), probably pointing to November as the start date. 

A bad number today will mean the Fed likely delays its decision on tapering, and this means there will be further stimulus to come and more asset purchases - likely driving asset prices (homes, stocks etc) higher. 

What do economists expect? 

Well I wouldn't pick any individual economist forecast and treat it as gospel, the range of estimates for this month is from 400k to 1m, so a range of 600k. Anything within this range will at least partly be in the price in the market already. But the consensus estimate is for around 700k jobs added (right in the middle of the range). 

Source: Bloomberg

In theory then, if the actual number is 700k, the market shouldn't move as it was already "expecting" this print. 

Is the Change in Nonfarm Payrolls Number the be-all and end-all this month? 

In normal times, it would be the payrolls number which would be closely watched, and the unemployment number less so (because it would be less volatile). However, we know that there are still millions of Americans fewer working at the moment than before the pandemic. A number of reasons have been given for this including stimulus cheques and enhanced unemployment benefits disincentivizing work. However, many of these effects are now wearing off and people are returning to the labour force. Thus, if more people start to seek work, the unemployment number could rise even if there is a million jobs added in the payrolls report. 

Looking at the participation rate, clearly there is still a long way to go to reach pre-pandemic levels. 

US Participation Rate - Source: Bloomberg 

So this report is important because we need to watch not just the payrolls number but also the unemployment rate. If the unemployment rate climbs higher, the Fed could justify remaining on hold with its policy for another meeting. 

So what would you trade? 

For me, this payrolls report is all about the FX Market. I would not be interested in equities as the reaction function is not clear. For example, if we get a very large number of jobs added, say 1m, and we also see a decline in the unemployment rate, then this means that a) the economy is doing well and should be good for some cyclical stocks, but b) the Fed is likely to announce tapering which will increase the cost of borrowing and be bad for stocks. 

Thus, the reaction function is a little messy and I would avoid it. Instead, I would look to play FX as everything should be more simple here. If the number is better than expected, this will likely lead to higher US yields, and this will be beneficial for the USD. We have moved away from a RORO world where good data = positive risk = weaker USD to one where yields have become more of a driver. 

Source: Bloomberg - DXY Index versus US 10y yield. 

Clearly there is some relationship between the two, although RORO can become dominant when there are big equity moves so some caution is still required. 

Therefore, I would play the currencies which have the most correlation to moves in the 10y yield. This includes the typical safe havens like the JPY and CHF, but you could also make a fair case for sorting EM currencies if the data is significantly better than expected. 

Source: Bloomberg - Correlation Table between the 10y and other assets. CHF looks best with a statistically significant relationship. 

Game Plan: 

If the data is significantly better than expected, and the unemployment rate lower: 

Buy USDJPY and USDCHF

If the data is significantly better than expected, and unemployment rate higher: 

Difficult - probably stay on the sidelines until the market finds some direction. 

If the data is significantly worse than expected and the unemployment rate lower than expected: 

Difficult again - unemployment number probably outweighs payrolls number, buy USDJPY and USDCHF. 

If the data is significantly worse than expected and the unemployment rate higher than expected: 

This is an obvious one, sell USDs against everything. S&P500 probably also climbs higher on this at least in the immediate aftermath before falling back as markets become concerned about growth again. 

The first of these scenarios is probably the only one I have significant conviction trading, and where I would anticipate avoiding a reversal later in the day. 

Hit me up with any questions, please do feel free to leave comments, and message for a chat on more specific trade ideas.