Labor Report Impact

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The ADP was slightly better than expected, but also on a weaker trend than 2014. This morning the weekly jobless claims came in higher, at 277,000 vs. 270,000 expectations, but it was below the 300,000 level. That data is not great, but it is also not bad either. The question is whether or not the Labor Report will be a determining factor as to whether the Fed will raise rates or not.

Labor Report Impact

Many are focused on the Labor Report data and are setting expectations as to whether the Fed will raise rates. However, I am of the belief that a single Labor Report or even the current trend in the Labor Report data is NOT the or even a major consideration for Fed monetary policy changes. Blaspheme you say? Well let me explain.

The Fed does have a “Dual Mandate” which in the simplest explanation includes maximize employment and maintaining a dollar value (no deflation and limited inflation). Personally the employment part of their “dual mandate” is rather silly. Our Federal Reserve is the only central bank in the entire world charged with the responsibility of the nation’s employment. Yet the Fed does not control labor policies, fiscal policies, tax issues, or regulations – then HOW do we expect them to do their job that Congress has assigned to them. Their real only tool is interest rates – lower rates and jobs are supposed to magically appear and raise rates slows down job creation – or something silly like that.

Regardless of my misgivings of charging the Fed with a silly mandate, they are stuck with it and therefore we now give serious weight and consideration to the Labor Report as to whether or not the Fed will change interest rates.

Data Problems

So now it comes down to the data of the Labor Market to make this interest rate decision and there is a problem.

First the headline data is not giving us real resolution of the labor market. First the U3 unemployment rate does not measure the entire unemployment picture. Yet it is considered the “official” unemployment number by the government, so the Fed must consider it. A more accurate measure of unemployment is the U6, which includes the broadest unemployment picture. Another problem with the data is the participation rate, what percentage of the population the government decides to count as participating or not. The current participation rate is at decades low and that artificially lowers the U3 unemployment rate considerably.

U3 Rate – is it correct? – Courtesy of FRED

Second the unemployment rate, regardless of which one you use, is NOT indicative of job creation. It is not just a problem from the issues I mentioned above, but also that unemployment naturally has a an attrition rate built into the model as people no longer qualify for benefits they are no longer counted. It is possible, without creating any jobs for the unemployment rate to drop. We have actually seen this during the recovery.

Third the job creation headline numbers are broad measures and does not give clarity (without peering into the details of the data) as to how many of the jobs are temporary or part-time. We have had several times during the recovery in which we saw strong job numbers, but we actually had a decline in full-employment the entire net job creation was part time.

Fourth we measure both unemployment and job creation from two different data sets, a household survey and a payroll data report. In many cases they are very conflictive and it is hard to ascertain which one is more accurate as to the landscape of the labor markets.

Fifth are wages and again if we only pay attention to headline data and not peer into the details of how it is created it is hard to ascertain whether wages are stagnant, improving, or declining. There are huge differences between medians and averages. How much is impacted by hourly vs. salary. What are the benefit costs?

These are just the simple issues when reviewing headline data and unless you are an economic wonk and someone that likes to spend hours reading into the reports to extrapolate the details, we can easily assume incorrectly that the Labor Market is improving or declining.

Fed Knows

We know the Fed are a bunch of wonks and certainly sifts through the details. From the Fed’s assessment the headline data is not NEARLY as good as it seems to be. The Fed has made it abundantly clear as to their concerns.

First – they removed from their official FOMC statement on monetary policy ANY measure of the U3 unemployment rate as a measure for changing interest rates and monetary policy. Prior to the removal, Bernanke had actually set measures as to when the Fed would change monetary policy. They had used numbers of 6.5%, 6%, even 5.5%. But as the U3 fell the Fed continued to move the goal posts lower. At one point it just became absurd and so they removed it completely as a measuring tool for setting monetary policy. Recently (March 2015) Bernanke stated that it is even MORE complicated than it was before, that it was only a number we had to look at. Now he admits there are many dimensions. In December 2014 officials said long-term unemployment should be in the 5.2% to 5.5% range, recently as it fell lowered, these same officials lowered it to 5% to 5.2%. Frankly they don’t know and the problem is not the Fed it is the U3 rate and all its model problems and bias. The answer is simple, don’t use it – it is NOT accurate.

Second – the Fed has stated both in their FOMC statement and in public there concern about the “structural problems in the labor market”. They had defined this as several issues; partition rate, wage stagnation, part-time vs. full-time work.

If you use the U6, back in the participation rate decline and those falling out of the labor force, the unemployment rate is 14.7%. Simply looking at the chart provided by the Fed below, shows that prior to the recession even when fully calculating in the participation rate and the drop in labor force, the U6 rate is at 7.5%. So there is no doubt, based on the government data that participation rate as well as those falling out is significantly impacting the unemployment headline data. This again is FED data – so they see the exact same thing.

Compare the two graphs. First one is the U6 prior to any Particiaption Rate or Labor Force Outflows. The second is the U6 adjusted for the Participation Rate and Labor Force Ourflows (unemployeed to not in the labor force).

Notice that before the Great Recession they track with each other. Then after the Great Recession they diverge. This divergence comes from the change in the particpation rate and labor force outflows only.

U6 rate – courtesy of FRED

U6 rate adjusted for participation and outflows – courtesy of FRED.

The Fed admitting to the problems in measuring the labor market and the headline data accuracy, then removing it as a measure and consideration for changing monetary policy should be proof enough that they don’t have confidence in the number and the headline data is NOT a consideration for monetary policy.

Yet the market doesn’t seem to understand this. The President and other politicians continue to parade out the headline numbers as huge success of the recovery and we certainly don’t want to pop the moral balloon. The economist and analyst in the media continue to give the Labor Report huge weight as to the economic health and whether the Fed will or will not raise rates. Lastly the financial media focuses on this as the single biggest government data report and that only further fuels the market reactions.

Does Labor Matter?

Fact is, if we are really at 5.1% unemployment and creating the millions of jobs and everything is as great as the headline data suggest – then how come the Fed has kept rates at zero, continues to expand the money supply, and continues to buy bonds and assets?

Reason and logic would dictate the labor market is not nearly as strong as the headline data suggests and there are other forces that are keeping the Fed from hiking rates and ending their accommodative policies.

Conflicted? I say so – yet the Labor Report remains the most highly anticipated and one of the largest government economic data points that can move this market and change perception. So while it probably has little or no bearing on the Fed’s actual policy decisions, it certainly can move the market because we still believe it does.

Market Expecations

Expectations are for 206,000 jobs and 5.1% U3. Here is what I believe will be the rate expectations and market reactions.

>250,000 jobs created and U3 < 5.2% = Rate Hike Expectation = Market comes under pressure.

190,000 – 220,000 jobs created and U3 5 to 5.4 = Uncertainty and Debate = Market volatility

<175,000 jobs created and U3 >5.2% = No Rate Hike Expectations = Market finds support and can rally.

There is certainly slop in there and I think it will come in around 198,000 jobs created and 5.2% U3. That would leave the uncertainty and debate roaring along until the October FOMC meeting. It would also give Yellen some breathing room as a reason NOT to raise rates.

Support & Resistance

INDU 16,000 – 16,400
Unless we get some blow out numbers at either extremes in the labor report, this is the sloppy range I think we will be dealing with as we heading into OCT FOMC meeting.

NDX 4000 – 4400
It’s wide range, but this can be a very volatile index – beyond any Fed decision. Expect volatility.

SPX 1880 – 1960
Again a wide slop range and it will see action based on the Labor Report and setting expectations.

RUT 1080 – 1120
The Russell is not showing much hope for a strong rally. If we get a real dismal labor report, which is initially bad news and can send this market lower, it could help put a bottom in the market as it increases expectations of a more accommodative Fed.

Labor Report will certainly drive perception, but I don’t think this Labor Report regardless of results will determine any Fed monetary policy. No doubt it can be used for justification of Fed action, especially if it comes in at the extremes.

QE4 or other easy monetary policy is certainly also in the cards, yet everyone seems to be myopically focused on rate hikes.

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