US nonfarm payrolls – Friday, August 4th 13:30 (BST)

The US dollar is looking for some good news this week as it seeks to snap a pretty poor run of things. The dollar index (DXY) has skidded to its weakest since January 2015 on political instability and longer odds for another Fed rate hike this year. A very crowded short dollar trade, with positioning at its most bearish in eight years, creates the environment for a sharp reversal but we’d likely need to see something really impressive from the NFP to spark the short squeeze.

Firstly, it will need to be a significant beat on expectations to really alter the mood in the markets, which has turned decidedly bearish on the dollar. Second, we’d need to see a big jump in earnings to alter the dial on inflation. It looks like the market is seeing things as half-empty at present in terms of the Fed so a small miss could further hit the dollar as it would likely see the market row back expectations for another rate hike this year a tad more.  A big beat could spark a pullback for the dollar but longer term it’s hard to see anything in this release to significantly alter the dial for the Fed.

Forecasts: Consensus estimates put the headline NFP number at 181,000, down from June’s bumper 222,000 and bang in line with the longer term trend. The June figure might be revised down as it does look quite high. Employment growth has so far averaged 180,000 per month in 2017, close to the 187,000 average last year.

ADP figures this week were pretty consistent but we would always caution that they are not a particularly reliable guide to the official nonfarm statistics from the Bureau of Labor Statistics.

Non-farm private employment rose by a seasonally adjusted 178,000 in July, which was a shade below the 185,000 forecast. The June figure was revised up to 191,000 from the previously reported 158,000.

The unemployment rate is expected to move lower again, dropping to 4.3% from 4.4% in June. Of note the Fed has already forecast unemployment to be lower. However the headline unemployment rate is not the best guide and masks the amount of hidden slack in the labour market that is keeping the lid on wages. This hidden slack is behind the Philip’s Curve breakdown that has seen wages fail to rise as quickly as the unemployment numbers would suggest they should, and as a result ensured that inflation remains below target despite a healthy economy and lots of stimulus.

The problem is the labour force participation rate, which has collapsed since the financial crisis. This was around 66% in 2008 and is now below 63%. However, at 62.8% it changed little in June and been pretty sideways for the last year. This might at least suggest that the decline in the rate has stabilised. A one per cent rise in the labour force rate is equivalent to two million new workers - that is a huge disinflationary pressure on wage growth. Meanwhile the huge structural problem of low productivity growth is ensuring wages don’t rise.

Indeed, at its June meeting the FOMC lowered the median estimate for the long-run unemployment rate from 4.7% in March to 4.6%.

At the same the Fed thinks inflation is not going to accelerate as quickly this year as previously. Policymakers downgraded their forecast for core inflation in 2017 from 1.9% in March to just 1.7%, a sign that they are clearly concerned about disinflationary pressures taking a grip.

This all looks minor but, taken together, highlights how the Fed thinks the correlation between unemployment and inflation is decoupling and that the headline employment numbers don’t matter so much for inflation.

It’s impossible to stress the point enough - full employment is not what it suggests when the labour force participation rate has cratered. The market has to start paying less attention to the headline nonfarm payrolls and focus on the deeper employment data.

So, if the headline NFP and unemployment numbers don’t matter as much as they did 18 months ago, we must look at average earnings as the key inflation marker. In the year to June, average hourly earnings rose by 2.5%.

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