USD: What Service ISM is Signaling for Payrolls

The U.S. dollar is trading lower this morning as the "ambitious" austerity package from Greece boosts demand for European currencies. However with short euro and pound positions reaching extreme levels last week, traders should realize that buying euros or pounds to cover shorts is completely different from buying the currencies because of a fundamental change in the outlook for the European economy. There is an article in the WSJ today about how the Justice Department has launched an investigation into whether hedge funds might have banded together to drive the euro lower. Whether this is true remains to be seen but it does provide another reason for hedge funds to cut their shorts at this time. We also know that in many cases, by the time professional traders disclose their positions it is too late to join the trade because they are looking to get out. In the meantime, the German government announced that they will not be offering aid to Greece. There has been alot of back and forth on this issue and until a final decision is made, the rally in the euro may be limited because of the risk of holding euros.

Service Sector Activity Expands at Fastest Pace Since July 2007

Meanwhile the release of a number of U.S. labor market reports has traders shifting their focus to non-farm payrolls. Although payroll provider ADP reported the smallest decline in 2 years, the 20k drop in payrolls still marked the 25th consecutive month of net job losses. The amount of job losses in January was also revised down from -22k to -60k, tempering the dollar's reaction to the report. The primary reason why economists are looking for more job losses is because of the rise in jobless claims, the snowstorms in the Northeast and now the negative ADP report. However a weak NFP number is not a done deal. According to Challenger Grey and Christmas, layoffs hit a 3 year low last month as planned firings fell 77 percent. The employment component of service sector ISM also rose to the highest level since April 2008. Despite slower growth in the manufacturing sector, the service sector expanded at the fastest pace since July 2007.

As indicated in the chart below, non-farm payrolls has a very strong correlation with the employment component of non-manufacturing ISM. Although one of our highly observant readers pointed out that there has been virtually no correlation over the past 6 months (-7 percent), over the past year the correlation has been greater than 83 percent and over the past 10 years it has been greater than 87 percent. Therefore it should just be a matter of time before this historically significant relationship is repaired.

May The Force Be With You.
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