Will NFP Motivate or Obliterate the U.S. Dollar?

2016-09-01 13:18:00

Talking Points:

- Non-Farm Payrolls for the month of August is set to be released tomorrow at 8:30 AM ET, and given the recent hawkish commentary from the Fed and strength in the U.S. Dollar, considerable focus will likely be directed towards the release of this print.

- The July FOMC meeting was very similar to the April meeting in which the bank went ‘less dovish.’ And like we saw after the April meeting, continued hawkish commentary from the Fed eventually prodded the U.S. Dollar higher. But in both of those scenarios, we’ve seen rate-hike expectations reverse quickly on a single negative data print. With rate expectations running higher again, are we due for a recursion should NFP (or any other relevant U.S. data point) comes in below expectations?

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June 3rd and July 29th; these are days that should stay fresh on the minds of traders and investors for the next three weeks as we approach the September FOMC meeting. After the Fed spent much of August talking up higher rates, markets didn’t really respond until last Friday when the joint chorus of Janet Yellen and Stanley Fischer finally began to prod U.S. rate expectations higher. The big driver appeared to emanate from Mr. Fischer’s television interview that started shortly after the beginning of Chair Yellen’s speech; and in that interview Mr. Fischer was concertedly pointing out that forward-looking data will shape the bank’s rate-hike plans. And this isn’t new; the Fed has been ‘data dependent’ for more than a few years now, with particular focus over the last year as the bank has staged multiple attempts at guiding rate expectations higher . But yet we’ve only seen one actual rate hike in the past nine years, so market expectations, acting on observed history, have built-in a tendency to expect the Fed to stay loose and passive.

On both June 3rd and July 29th of this year, markets got negative pieces of U.S. economic data that caused rate hike expectations to get crushed. In both instances, an out-sized reversal took place in the U.S. Dollar as weeks’ worth of gains were erased in a single day, driven by an individual data point.

On the chart below, we’re looking at the U.S. Dollar over the past five months with the two significant bearish reversals highlighted in red.

Created with Marketscope/Trading Station II; prepared by James Stanley

Will NFP Come Out Negative?

Really, nobody knows. NFP is the closest thing to a roll of the dice that markets may be forced to go through. The benefit of the data print is also its drawback, and that’s the fact that it’s an ‘early’ look at the most recently completed month of economic activity; this is why so many market participants watch this number so closely, it’s the first look at employment for a monthly period of activity. Unfortunately, because of how early it is this number also has a tendency to be a bit dirty; as in, the number will often see multiple revisions in the forward month(s).

But also due to the early nature of this release, there is a lack of forward-indication of how it might actually print. So be very, very careful if looking to trade on Non-Farm Payrolls: It’s a dangerous endeavor. This is also why NFP presents the opportunity for the initiation of new trends: Markets are getting new, fresh data that can shape forward-looking expectations for near-term economic behavior.

The expectation for tomorrow’s NFP print is for 180,000 jobs to have been added to American payrolls in the month of August. Given that the U.S. Dollar has been running higher as fueled by this recent FOMC commentary with specific focus on employment strength, we’d likely need to see a 190k+ print to elicit any additional significant USD drive.

For that scenario, USD/JPY continues to be an attractive venue to voice those themes of Dollar-strength. While the additional stimulus out of Japan is far from a certainty, the September BoJ meeting is lining up to be very interesting and given their pattern of ‘risk-taking endeavors into the realms of stimulus,’ it wouldn’t be surprising to see the bank come out with some type of ‘surprise’ on 9-21. Regardless of that situation, the BoJ probably isn’t going to be close to hiking rates anytime soon, and this could expose Yen weakness in the event of USD-strength as a simple monetary divergence play.

This is a theme that we’ve been fairly vociferous about over the past month, and if you’d like to read more about the setup and scenario please check out our article, Gold, Yen Primed for USD Volatility around Jackson Hole. And if you’d prefer a video, this was the focus of our webinar last Tuesday and you’re more than welcome to check that out.

Created with Marketscope/Trading Station II; prepared by James Stanley

Traders Continually Need to Attempt to ‘See Around the Next Corner’

Game theory dictates that by the time we know or see something, it’s likely too late (because others are also seeing and observing, obviating any advantage of time, and this is the reason that ‘trading’ NFP can be so dangerous). In markets, we must anticipate, or at the very least begin planning for adverse scenarios that may run counter to our primary thesis.

If we do, in fact, get a recursion of June 3rd and July 29th, then we’ll likely see a weak U.S. Dollar as driven by diminishing rate hike hopes. This could be initiated by a sub-150k print, and if this does happen, look for areas or markets that have prospered recently in the face of USD weakness. One market that we’ve been talking about heavily for that approach has been Gold, but there’s no use in rehashing that here; if you’d like to read more about Gold setups in the event of USD weakness, please check out our Technical piece on the Gold market released earlier in the week.

Today, however, we’re going to look at another market that may shine in the face of USD weakness, and this is one that many probably wouldn’t expect to see gain bullish traction; and that’s the British Pound. We discussed the context of this setup yesterday in the article, Carney’s Lament, and this is a case of rate expectations moving so low, so fast that now reverberations are beginning to show.

Brexit was scary. It was brute uncertainty; nobody really knew what might happen. The BoE was sure that doom and gloom was ahead and quickly adjusted rate expectations for fear of impending pain. But as the bank got uber-dovish in the wake of Brexit, this drove the British Pound to fresh 30-year lows. And now with GBP trading so far below its longer-term historical averages, inflation is beginning to show in the British economy as driven by higher import prices. For an import-heavy economy like the U.K., this could carry a strong effect of inflationary pressure that could force the Bank of England’s hand away from future rate cuts.

So despite this new-found fad of USD strength, GBP/USD has continued to work into a bullish longer-term formation as we looked at yesterday; and should USD-weakness take over, again, as we saw on June 3rd and on July 29th, long Cable could be an attractive candidate to trade that theme given the expectation for a continual increase in inflationary pressure for the British economy.