USD Could Sink on Payrolls Surprise

NEW YORK (BBH FX Strategy) -- In terms of foreign exchange we look for the dollar's reaction to the payroll data to be consistent with the recent market correlations.

That means, given the recent sharp swings in market positioning and resulting demand for dollars, we expect any strong upside surprise in payrolls (which we could define as an increase in private payrolls of 120,000 of more) to be met with dollar selling against the dollar bloc in particular.

We are basing this in part on the dollar's recent response to upside surprises in payrolls: the dollar, on average, declined by nearly 0.85% vs. the AUD, CAD and NZD following the release. Conversely, a negative payroll report (private payrolls in the 60,000 to 90,000 range) is likely to extend recent trends as momentum traders continue to push the dollar higher against the EUR and other currencies sensitive to risk appetite.

Private payrolls disappointed in the last three out of four reports with an average miss of 80,000 jobs. Subsequent currency performance for the downside surprises, on average, showed the dollar increasing by over 1% against both the EUR and SEK, along with sizeable gains of nearly 0.85% against the NZD.

Today's upside surprise in ADP private payrolls indicates that while U.S. labor market conditions remain soft, conditions continue to improve, albeit modestly. Indeed, the better-than-expected ADP report does indicate that the risks to Friday's payroll report are to the upside, driven by the fact that the ADP report is unaffected by the strike of 45,000 Verizon workers in August (the ADP survey only includes workers that remain on the payroll list and of course the strikers are not paid). Nevertheless, discounting for the Verizon strike the ADP results would be consistent with gain of roughly 136,000 workers in September and would indeed be much better than the consensus estimates. Against current market expectations the potential for a 136,000 gain in payrolls would be a greater than one standard deviation upside surprise.

Based on recent history, though, the ADP results should be taken with a grain of salt due to its dubious predictive power of the private payroll report. After all, since December 2008, ADP's average forecasting error has averaged nearly 90,000, while in 2010 and 2011 ADP undershot expectations by nearly 32,000 -- based on the median forecasting error.

More recently, the ADP "bias" has averaged a tiny 3,000/month overshoot thus far in 2011, which is just a 3,000 undershoot ex-Verizon. Taken together, given BLS guidance of a 16,000/month average boost in payroll growth over the 12 months ending in March, the small ADP overshoot seen thus far in 2011 will likely translate to a small undershoot, bringing the historical forecasting in line with its long-term median value of a 5,000 undershot.

Notwithstanding the forecasting errors of ADP, the highest frequency jobs report we can rely on is the weekly initial jobless claims. Admittedly, the four-week initial jobless claims moving average has remained somewhat resilient in the face of the market turmoil in August and September. And while the four-week initial jobless claims moving average has begun to tick back up in response to the deterioration in market conditions, the index is still off its recent peak in late April, suggesting the labor market is likely in better shape than the survey data portends.

What's more both the Monster Employment Index (which provides a snapshot of employer online recruitment activity nationwide) and the three-month moving average of the Conference Board Online Help Wanted Advertising Index also suggest the trajectory for payroll growth, while horrendously slow, is still positive.

Today's spike in the Challenger survey does contrast with the high-frequency initial jobless claims and other employment-related trends, which if it persists could be a negative sign for the employment situation. We, however, continue to think that the trajectory for job growth is likely to remain positive. Of course, it will not be fast enough to impact the sizeable output gap that persists in the U.S. but faster than the double-dip fears that have plagued the market since the summer.

This commentary comes from an independent investor or market observer as part of TheStreet guest contributor program. The views expressed are those of the author and do not necessarily represent the views of TheStreet or its management.

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