Market alert: NFP report crucial for the EURUSD, stocks

The markets seem certain that the next move from the Fed will be a cut in interest rates. In fact, a cut is fully discounted by September and seen by many as soon as this month. In this context, the labour market developments might be decisive for major markets like EURUSD and the US500.

Summary:

• US500, EURUSD await decisive NFP report
• ADP, ISM offer contradictory suggestions regarding labour market
• Data will be released at 1:30pm BST (14:30 CEST)

US500  

Let’s start with stocks. The US500 saw a major correction in May as trade conflict erupted, but has recovered substantially in June so far on hopes of a rate cut. Lower rates are naturally good for stocks but only if economic conditions are good. Here’s the catch: a strong gain in employment could delay a rate cut decision but would at least sooth slowdown concerns. A weak print (below +100k) could seal expectations for an imminent rate cut but investors could be worried once again that such a cut would only confirm a looming economic slowdown (over the past 3 decades, the beginning of an easing cycle always preceded an economic slowdown).

Looking at the chart the index returned above the 2800 level which once again serves as a support. The next resistance is at 2870 points – a reversal below that level could confirm a downward trend.  Source: xStation 5

EURUSD

The European economy started to disappoint in early 2018 and for many months the US economy was in a much better shape which translated into a persistent EURUSD decline. However, as the fiscal impulse in the US economy starts to fade, the latest reports have been disappointing as well. If the US labour market softens, that would be another sign that the US “converges” with the EU in terms of weak economic conditions and that could have serious ramifications for the EURUSD.

EURUSD broke out of the downward wedge and quickly surged to 1.13, showing determination of the bulls. One may notice that the real support is as far as 1.1515 with a weaker level at 1.1425. Therefore a weak NFP could be a mover on this currency pair. Source: xStation 5

Can we predict the NFP report?

In June, all the “minor” reports like ADP and ISMs for May have been already released. The problem is that they pointed in completely contradictory directions. The ADP was the weakest since March 2010, showing just a 27k employment gain in the private sector. ISM employment composite (we use 15% manufacturing and 85% non-manufacturing) was at 57.4 points – the highest since January, up 3.9 points from April. It was also only the 8th month with a reading of at least 57 points in this decade. So which measure should we trust?

ADP has shown a fairly strong correlation with the NFP, especially when it disappoints. Source: Macrobond, XTB Research

On the chart we can see a stronger correlation with the ADP but one can see that on a month to month basis, these measures were often quite different. There were 5 occurences over the past 9 years where the ADP was lower than +90k. The average private NFP was just +72k in those months, while four out of five were below +100k and the best reading was +130k. So the predicting power of a poor ADP seems to be strong but the sample is low.

ISM surveys have overstated employment gains recently. Source: Macrobond, XTB Research

On the chart of private NFPs and the ISM composite, we can see that the correlation was strong in the first half of the decade but more recently, the picture shown by the ISM has been generally overstated. Additionally, in seven months where the ISM was above 57 points the average private employment gain was at +208k, just 10k above the mean for the past 9 years. There hasn't been a single occasion this decade where the ADP and ISM have sent as contradictory message as the one they are sending at present - and as such we are heading into uncharted waters with little by the way of precedent.  Finally, May has been a below-average month during this decade so it looks like a weak NFP reading is a bit more likely. However, this is a very volatile number (and often revised) so investors should be ready for any outcome.