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NFP preview: the devil is in the wages

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In US labor report the initial focus is always on non-farm payrolls (NFP). However, the pace of job growth for months has been more than satisfactory, while the Fed is looking for signs of wage pressure to bolster inflation. Therefore, data on wages on Friday may have stronger implications for the path of Fed rate hikes, and consequently also for the dollar.

The labor market report is a key US release as it is crucial for Federal Reserves dual mandate, where the two goals are: price stability and maximum sustainable employment. As data on employment change are usually the most prominent, they will decide on the first reaction from the market on Friday at 14:30 CET. This is partly due to the fact that trading algorithms are usually set up under employment data (number above consensus = buy USD).

But nowadays employment is not the most important thing. In recent months, job growth has been solid enough to not cause Fed concerns. This was highlighted in a statement after this week’s FOMC meeting. Even the downside surprise in March (98k, with the average for the previous 12 months at 205k) did not affect FOMC members view. Therefore, the durability of dollar reaction will be determined by average hourly earnings (AHE). This is because for the Fed the critical question is whether the strength of the labor market will translate into wage pressure and will allow inflation to accelerate toward the 2% target.

If data confirm consensus (NFP 190k, AHE 0.3% mom, 2.7% yoy), there should still be a result advocating for strengthening the USD. The justification is that the dollar should catch up the reaction to slightly hawkish FOMC message from Wednesday. Although the interest rate market has increased the pricing of the June hike from 62% to 98%, the dollar rose only moderately. That is why we think that good data would increase investor confidence in the dollar.

For a clear rally the US dollar needs strong wages at a solid employment growth. This would open the door for speculation about another (third) interest rate hike this year, on which the market maintains its conservative expectations (54%). The strongest impulse will be with the wages growth at 2.8% year-on-year. In this case even NFP less than 160k could be ignored. Monthly AHE at 0.4%, but with maintaining annual rate at 2.7%, might be explained in rounding numbers, which will weaken the impact on the markets. Poor wage readings (<0.2%) will be more pronounced than lower employment growth. In this case even a solid NFP (above 220k) won’t be able to neutralize AHE disappointment.

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