NFP preview do NFPs matter now that a rate hike is signed sealed and yet to be delivered

This Friday at 1330 GMT the eagerly awaited February NFP report is scheduled to be released. The market is expecting a reading of 197k, while the unemployment rate is expected to fall further to 4.7% from 4.8%, and earnings growth is set to rise to 2.7%.

ADP report paves the way for a big NFP number

Expectations for an even bigger NFP number have been stoked by an extremely strong ADP report for February, which measures private sector payrolls in the US. This came in at 298k, vs. expectations for 187k, the largest reading since April 2014. If the NFP comes anywhere near this level then it will virtually solidify expectations for a rate hike from the Federal Reserve next week, especially if job gains are broad-based and focused not only in the strong services sector, but also in the manufacturing and construction sectors.

Why the ADP matters for NFP expectations

The ADP report doesn’t always track the NFP report perfectly (see the chart below), however, this statistic gives us confidence that we could get a bigger-than-expected NFP number on Friday: since the ADP changed its methodology in October 2012 there have only been three occasions when it has beaten the NFP reading by 100k or more. On the back of this ADP report economists have rushed to revise their NFP forecasts higher. There have been other upbeat signals about jobs growth in the US too, including the ISM non-manufacturing report for February, the unemployment component rose to 55.2 last month, reversing some recent weakness in the employment component of this index.

A March Fed rate hike now fully priced by the market

The key theme in the market right now is expectations of a Fed rate hike next week. On the back of the strong ADP report, the market is now fully priced for a rate hike next week, with the Fed Fund Futures market pricing in a 100% chance of a hike on Wednesday. Thus, does the payrolls number, if it comes in line with expectations, actually matter for US asset prices? Possibly not, as a rate hike should be fully baked into the dollar and US stock prices. From a markets perspective, it will only matter if the NFP report and US wage data actually disappoint to the downside. Then the market is likely to have a sharp reaction, with rate hike expectations falling, dragging the dollar and even the US stock market lower. We should point out that we expect a weak NFP report to be a low probability, high volatility event.

A strong payrolls report yet a muted USD reaction…

If, as we expect, we get a good jobs number his Friday then the dollar reaction is worth watching. We may see a sell-off on any spike higher in the dollar, as the market is heavily positioned for a Fed rate hike. USD/JPY is particularly sensitive to payrolls data, so any move back above 115.80-90, the 50% and 61.8% retracement of the December to February decline in USD/JPY could be met with some selling pressure.

The stock market reaction could be more nuanced. While a strong economy is good news for US stocks, and a strong jobs number suggests a high level of business confidence in the US, a positive labour market report could boost expectations for a third rate hike from the Fed in June. Post the ADP report, the market is expecting a 50% chance of a subsequent rate hike in June, if this rises on Friday then the stock market could struggle, as the saying goes: “three steps and a stumble”. If financial markets start to believe that the Fed is hiking rates at too fast a clip then we could see the S&P 500 and the Dow start to slip.

Overall, while February’s NFP report is important, a number in line with expectations is likely to be met with a muted market reaction, as a Fed rate hike is now fully expected by the market. A weaker than expected reading would likely to trigger the biggest market reaction and a surge in volatility.

Figure 1:

Source: City Index and Bloomberg