December Nonfarm Payrolls Primer - Looks Like a Mug's Game To Me

Good Evening. 

Tomorrow will be the first Friday of the month, and that means it is time for the Nonfarm Payrolls report. No doubt, this is going to be a tricky report to read. On the one hand, there is all of the seasonal stuff and adjustments which occurs over Christmas holidays, then there is the COVID-19 disruptions still playing out with Omicron, on top of that we have a Fed which is becoming more and more hawkish, so the impact for markets may have to be a bit of a play it by ear approach. 

This one seems like a mug's game to me :) 

Nonetheless, despite the seeming difficulty of the upcoming report, I will do my utmost to guide you through it in my usual style. My main advice for tomorrow's report is don't expect the first move to be the last one. This payrolls report will no doubt take time to digest - with many moving parts like unemployment rates, participation rates, and seasonal adjustments. ALL OF WHICH means the initial ALGO REACTION may be over/underdone. 

Where are we now? 

Source: Refinitiv

The most important thing to remember is that we've had some pretty hefty shocks to the payrolls report over the last few months. The November number was miles from consensus with 550k estimates and 200k added. 

But this is not the only cog in the payrolls machine. We also have the unemployment rate (below) which has been trending down, but the Fed is probably not comfortable when we also consider that 4m fewer people are in work than before the pandemic. 

Source: Refinitiv 

Likewise, the participation rate has been pretty important. Following the ADP report on Wednesday, where a whopping 800k private sector jobs (apparently... always take ADP with a pinch of salt ;) ) were added (against consensus of 400k or so). If the participation rate ticks up noticeably, this will actually be a sign of dovishness since it means people are returning to the workforce, which in turn implies that inflationary pressures (particularly on wages) are likely to ease. 

If not, then the Fed may have a more severe inflation problem on its hands - particularly in those low skilled jobs where wages have had to rise dramatically in order to incentivise people back into the labour force. The participation rate can be seen below. 

Source: Refinitiv - Participation has lagged the decline in unemployment 

WHAT'S EXPECTED? 

Currently, the consensus estimate is for 400k jobs to be added and for the unemployment to drop to 4.1% from 4.2% prior. HOWEVER, the underemployment rate is expected to move higher! Despite a big increase in jobs! To me, this is saying the market is clearly expecting a bit of an uptick in participation this time around. 

There is a HUGE DISTRIBUTION though in the range of estimates, with Pantheon Macro top of the pile with 1.1m expected. 

Source: Refinitiv 

WHAT'S THE TRADE? 

For me, the only way to play this is via FX. If we get a big headline beat on the outright payrolls number EXPECT A KNEEJERK STRONGER USD. 

This would be in-line with the Fed feeling more comfortable about possible tightening. However, if participation / underemployment show there is increasing slack in the labour market, this could cause a pretty quick reversal. 

MY TAKE: 

My forecast is for a payrolls number around 800k - roughly in-line with the ADP forecast from the other day. 

Certainly, I think the balance of risks is to an upside surprise in payrolls - and if we get this along with other labour market metrics tightening - i.e. participation stubbornly low and under-employment not rising too much, this could be a pretty hawkish signal as it will be indicative of broader pressures in the labour market. 

This would obviously be negative for gold, bullish for USD, and bad for equities. The Fed has been very aggressively pivoting to a much more hawkish position however, and I continue to believe that the Fed acting too quickly is the biggest risk to the outlook for US equities, although it will be longer-term bullish for gold. 

The market is currently pricing in three Fed hikes this year already. To me, this seems mad, and I do believe that this is too aggressive for 2022, basically no matter what the payrolls report is. 

My advice, stay out of this one and watch from the sidelines. It's going to be brutal for someone at least :) 

Happy Trading.