Scenarios for Tomorrow's Non-Farm Payrolls:

The consensus forecast for July's NFP tomorrow is for a gain of around 90K-100K. The ADP and Challenger data this week gave us a mixed picture, but we should be able to escape the very weak job growth seen in May and June.

Better Than Expected: If payrolls come in stronger than the reading expected, say 115K and above, that will be a positive for the USD as it will be a small bright sign in what has been a string of weak data. A gain of 130K+ would certainly ease some of the major concerns revolving around weaker consumer spending as households remain concerned both about jobs, the economy, and higher energy and food costs. If we see companies adding jobs even despite the debt ceiling debate during the month, it will be a shot in the arm for financial markets and give the USD some relief. This scenario falls into the lower probability category.

Status Quo: A reading in the range of 90K-100K will show some improvement compared to the previous 2 months, but its a rate of job growth that is slower than what is needed to keep up with new entrants into the labor force and will not dent the persistently high unemployment rate - now at 9.2%. A reading above 150K is needed to do that. Therefore, while it avoids a negative surprise, the reaction here would be to continue to factor in a slow muddled through recovery as we move through the 3rd quarter. The reaction in currency markets may be volatile and depend on other factors such as general risk sentiment.

Weaker than Expected: If job gains come in weaker than 80K, it would be another negative piece of data added to the US data-stream, and if we see job growth below 50K, then the calls for QE3 will only grow louder. A miss by payrolls here would solidify expectations that the US economy is hobbling and sputtering as we began the 3rd quarter, and that the 2nd half growth spurt that Bernanke said was coming, may not materialize. Such a scenario would be USD negative, but it would also undermine confidence in financial markets generally, pressuring higher yielders at the expense of safe haven currencies like the CHF, JPY, and gold.

Since we have had moves by both the SNB and BOJ to stem their currencies rises - with the Japanese opting for direct intervention - market participants may be at a loss as to where to find safety within currency markets. Commodity currencies have taken a backseat as global growth concerns have surfaced.

The safest asset seems to be US Treasuries with yields on the 2-year hitting record lows today, and yields falling all along the yield curve as traders and investors buy up US bonds and we see a sharp sell-off in equities prior to the NFP release.

Now let's review the releases we have seen this week to see if they offer clues to what we may see tomorrow.

Jobless Claims Straddle 400K Level

Jobless claims came in at 400K for the week ended July 31st, a reading that was mainly in line with expectations, even a tad better considering the consensus forecast of a 404K reading. The previous week was revised upward by 3K to 401K from 308K.

Still overall, its 2 weeks in a row that we straddle the very important 400K area, as readings below 400K are consistent with about 150K jobs created for the month. If we saw a NFP figure for July around 150K it would be a nice surprise to markets as the consensus forecast currently is for around 90K-100K jobs.

Yesterday we saw 2 job reports that gave us mixed signals about what to expect from tomorrow's NFP.

ADP Employment Change Affirms NFP Consensus Forecast, ADP Needs to Win Back Traders' Trust:

The ADP Employment Change for July beat expectations posting a 115K increase in private sector jobs for the month. Now, the ADP came in for strong scrutiny last month as its gain of 154K strongly overshot the actual NFP figure of 18K. Therefore traders are taking yesterday's reading with a grain of salt.

The pattern for the ADP release has been to undershoot the private sector gains seen in the NFP figure as we can see from this image below (taken prior to last month's NFP reading):

Here's another view of the difference between ADP and NFP:

Except for last December and January, and the previous month June, ADP has come in lower than the private NFP reading, and a common adjustment is to add 20K-30K to the ADP number to try and give an indication of where NFP may come in. We'll see if that pattern can re-assert itself in today's report which would give us an expectation that the economy created 145K private sector jobs.

We would then subtract 20K or so for the expected loss in state and local government jobs, which has also been a recent trend as governments trim their budgets. We therefore get to a figure of 125K if we use the ADP data. Again, the ADP lost some of its trust with traders after last month, so we'll see if it can improve its accuracy this time around.

Challenger Sees Firing Intentions at 18-Month High

A second report yesterday - the Challenger Job Cuts - showed that big firms had increased their plans for layoffs, and the 56.4% y/y change seen for July turned out to be the highest reading in 18 months. That compared to a 5.3% reading for June.

From Wall Street Journal: "U.S. employers announced plans to cut 66,414 positions from their payrolls during July, surging 60% from June, and hitting the highest level since March 20l0 amid a flurry of layoff plans by major employers, according to a report by the outplacement firm Challenger, Gray & Christmas Inc.

"July marks the third consecutive increase we have seen in monthly job-cut announcements, which certainly seems to provide additional evidence that the recovery has stalled," Challenger Chief Executive John Challenger said. It was also the first time in seven months that the government didn't represent the biggest portion of job cuts.

The July increase was up 59% from a year earlier, with layoff announcements from companies such as pharmaceutical giant Merck & Co. (MRK), bankrupt book-seller Borders Group Inc. (BGPIQ), networking giant Cisco Systems Inc. (CSCO), Lockheed Martin Corp. (LMT) and medical-device maker Boston Scientific Corp. (BSX). Layoffs at these five companies accounted for about 57% of the July total."

We'll see if this increase in intentions will push up the jobless claims figure in the weeks to come which would be a bad signal for the labor market considering we have gotten down to the important 400K level.

Overall, the jobless claims and ADP reports point to the NFP hitting the consensus figure, while the Challenger report helps the downside risk case.

With the amount of risk aversion in the markets currently, the NFP is going to be a make or break time for sentiment. A weak reading will exacerbate the sell-off in equities and increase pressure on the Fed to act with more easing, while a better than expected report can help to put a bottom under the recent stock declines. The currency markets will be pushed around by these expectations as well.

You can join myself and Fan Yang tomorrow at FXStreet as we hold a Live Coverage of this Event.

Nick Nasad
Chief Market Analyst