ADP Points to Weak Non-Farm Payrolls on Friday (page 1 of 2)

US Dollar - The US dollar staged a very strong rally today as the equity markets reopened after the long weekend. The peak in the US dollar coincided with the intraday peak in the Dow, which was up over 100 points at one point. Real money funds, who are unleveraged buyers such as mutual funds were snapping up US stocks and US dollars along with it. In the beginning of the year, we see a lot of portfolio reweightings that tends to be very positive for the US dollar. In fact, according to a seasonality study that we published last week, over the past 10 years, the US dollar rallied against the Euro (or Deutschemark pre-Euro), 80 percent of the time. However the EUR/USD found a bottom when the Dow gave back all of its morning gains. The fundamental outlook is not exactly supportive of a strong dollar rally. Even though the minutes from the Federal Reserve's December meeting revealed the central bank's concerns for upside inflation risks, today's economic data gives the central bank no choice other than to keep interest rates at their present levels even if they think that inflation is problem. This is especially true if the labor market data comes out weak on Friday. The Fed will be forced to put growth ahead of inflation. With oil prices breaking below $60 a barrel however, inflation will probably not remain a problem for very long. The ADP number was very weak this morning. According to the payrolls agency, US companies reduced their payrolls by 40k in the month of December. This is the first time we have seen a negative reading in the index since April of 2003. Back then, payrolls printed at -68k. The Hudson Employment index also posted a 2.6 percent drop. Taken together, we could see a very weak non-farm payrolls number on Friday. In fact, many banks have already dropped their NFP forecasts significantly. We could realistically see US companies add 50k or fewer jobs in the December. The dollar sold off on the report, but the sell-off did not last as traders began to price in the possibility of a firmer ISM manufacturing number. As they expected, manufacturing conditions expanded once again after contracting the prior month. However we would caution against being too optimistic about the report because there was underlying weakness. The prices paid component dropped significantly suggesting that inflation pressures in December may be far lower than the inflationary pressures in November. In addition, the employment component of the report remained in contractionary territory, which adds to the case that the labor market in general may have deteriorated significantly last month. If the labor market is weak, then the US economy has even fewer legs to stand on.

Euro - Broad dollar strength has forced the Euro to give back all of yesterday's gains despite exceptionally strong economic data. German unemployment fell by the largest amount in over 15 years during the month of December. Originally expected to fall by only 48k, the number of claimants actually fell by 108k, bringing the unemployment rate down from 10.1 percent to 9.8 percent, the lowest level since August 2002. Improving economic growth, warm weather (which is keeping the construction sector going) and the reduction of skilled labor has tightened the labor market significantly. In addition, with business confidence at 15 year highs, it should be not be very surprising that companies have returned to hiring aggressively as well. The improvement in the labor market should help to keep consumer spending healthy and delay any potential impact of an increase in the VAT tax.