Markets Cautious Ahead of NFP

NEW YORK (BBH FX Strategy ) -- Equity markets are treading water ahead of the U.S. non-farm payroll report, with the Europe Stoxx 600 down 0.5% in the morning European session and the S&P 500 June benchmark down 0.4% ahead of the open.

The news that the EU and IMF have completed a second bailout for Greece , staying true to the principle of "rolling over" Greek default risk into the future through conditional liquidity support, has helped shift the market focus away from peripheral woes, leaving the index of CDSs of 15 European governments down 7.5bps at 188.5. This leaves attitudes about the U.S. cyclical outlook and the equities reaction to the NFPs report in the driving seat.

The continuation of bullish flatteners in the U.S. yield curve, as investors revert to the view of a QE mode for the Fed for longer, is weighing on the U.S. dollar in a risk cautious, but orderly market environment.

Wednesday's disappointing ADP report, concurrent with an uptrend in the weekly jobless claims series and a marked slowdown in output on the production surveys, has prompted a wave of negative revisions for today's NFPs, pushing the market consensus down to 165k from 185k at the start of the week, compared with a 244k print for April.

Indeed, since the dismal ADP report this week subsequent forecasts have a median of 130k, with only seven of the 49 updated forecasts expecting payrolls to exceed 175k. Altogether, it appears that the market is bracing itself for a bad figure but what will this mean for the dollar? Given this overall shift in sentiment, we suspect anything above 165 would now have to be considered a positive surprise, which would likely lead to some knee-jerk dollar buying. That said, we would suggest selling the dollar into rallies as any rally is likely to be short-lived as policy normalization is likely to weigh on the dollar.

Conversely, you would probably need an outcome close to 85k or below to really shock the market to the downside. A reading this low is likely to add fuel to the nascent debate about whether the US economy is really in a soft patch or in fact headed for a double dip. In our view, a reading in line with consensus is likely to lead to more dollar selling and combined with the favorable news about Greece are unlikely to trigger a pronounced risk-off event.