The US dollar is selling off aggressively ahead of Friday's non-farm payrolls report on the fear that for the second month in a row, job losses may have topped 500k. The recent moves in the currency and equity markets suggest that everyone expects a very weak labor market report. Although the consensus forecast is -520k, the whisper number is closer to -650k to -700k. Sentiment is strongly skewed in one direction which can be dangerous considering the fact that some of the leading indicators for non-farm payrolls call for a rebound. The Non-farm payrolls report is the most market moving release for the currency market and it should live up to its volatility inducing reputation.

Why Non-Farm Payrolls Could Rebound in December

For many Americans, 2008 has been a year unlike any other. Companies across the nation have been forced to tighten their belts and move into survival mode, accelerating layoffs towards the end of the year. With the December numbers, more than 2 million Americans will have lost their jobs in 2008. In fact, jobs were cut every single month last year. Although everyone expects very weak job growth, there is reason to believe that we may see a rebound in non-farm payrolls. First, the employment component of Service sector ISM, which is one of the most reliable leading indicators for non-farm payrolls improved in December along with the University of Michigan Consumer Confidence Index. Since the US is a service based economy, the slower pace of job losses in the ISM report suggests that we could see a rebound in non-farm payrolls.

In addition, every single time that we have seen non-farm payrolls fall by more than 500k, there is a steep rebound the following month. In the past 50 years, we have had 3 cases where more than half a million jobs were lost in one month and in every single one of those cases, NFPs rebounded close to 50 percent. The improvement in service sector ISM suggests that the rebound could be seen again in December.

12 Consecutive Months of Negative Non-Farm Payrolls

With that in mind however, non-farm payrolls will still be weak and the unemployment rate will rise as all of the leading indicators for non-farm payrolls point to more job losses. The main reason why the whisper number is around -650k to -700k is because private sector payroll provider ADP reported that 693,000 jobs were cut last month. Given that non-farm payrolls came out worse than the ADP report every single month last year, this has led some people to believe that job losses in December could have been the largest in 5 decades. Unemployment rolls are also continuing to grow with the 4 week average of jobless claims and continuing claims at 26 year highs. Layoffs have risen 274.5% while online job ads have declined. Despite the rebound in the employment component of service sector PMI, the index remains in contractionary territory while the record low hit by the Conference Board's report of consumer confidence offsets the improvement in the University of Michigan data.

Here's how the 10 leading indicators for non-farm payrolls stack up for December:

1. Employment Component of Service Sector ISM Rebounds but Remains Contractionary
2. University of Michigan Consumer Confidence Index Increases Marginally
3. Employment Component of Manufacturing Sector ISM Hits Another Record Low
4. ADP Report Private Sector Job Losses at 693,000, A New Record Low
5. Challenger Reports that Layoffs Rise 274.5%
6. Conference Board Consumer Confidence Report Hits Record Low
7. 4 Week Average Claims at 26 Year High
8. Continuing Claims Hit 26 Year High
9. Index Falls 12 Points
10. Strike Activity Flat

How the Dollar May React to NFPs

A negative non-farm payrolls reading alone will not hurt the US dollar. Instead the greenback's reaction to the labor market report will depend on the severity of job losses. If non-farm payrolls fall by 525k or less, we could see a bounce in the dollar because these days matching expectations can have more of a positive than negative impact on a currency. If payrolls fall by more than 575k however we could see the dollar extend its losses, particularly against the Japanese Yen and Euro. The larger the decline in payrolls, the greater the potential sell-off in the US dollar. If NFPs comes anywhere close to 700k, the EUR/USD could surge towards 1.40 and USD/JPY could break 90. Keep an eye out of revisions as well which could add to the expected volatility post payrolls.

Here are the forecasts for December Non-Farm Payrolls:

Change in Non-Farm Payrolls: -520k (-533k Previous)
Unemployment Rate: 7.0% (6.7% Previous)
Change in Manufacturing Payrolls: -100k (-85k Previous)
Average Hourly Earnings (MoM): 0.2% (0.4% Previous)
Average Weekly Hours: 33.5 (33.5 Previous)

A Rebound Would be a Precursor to More Losses

If we really see a rebound in December non-farm payrolls, it would only be a precursor to another phase of aggressive layoffs. Alcoa and Intel have already announced another round of job cuts. In previous recessions, job cuts have lasted for at least 15 months (December would only mark the 12th month of layoffs). The current recession is the closest to the 1980s recession, when job losses continued for 17 consecutive months. Even the recession in 2001, which was shallower than the current recession had 15 consecutive months of job losses. Therefore non-farm payrolls should remain negative throughout first quarter. Furthermore, a large drop in non-farm payrolls does not mean that we have hit a bottom.

In analyzing non-farm payrolls data during past recessions, we see that at the beginning of an official recession, as defined by the National Bureau of Economic Research, non-farm payrolls start to decline rapidly. However after falling between 200k and 300k, job cuts stall and then pick up once again. We saw this trend in the 1981 to 1982 recession, the 1990 to 1991 recession and during the 2001 recession. This pattern could be repeated in 2009.