NFP Prep: Jobs Report Should Keep Fed on Track to Hike

<p>The July Non-Farm Payroll report will be released tomorrow at 8:30 ET (12:30 GMT, 1:30pm BST), with expectations centered on a headline print of 220k […]</p>

The July Non-Farm Payroll report will be released tomorrow at 8:30 ET (12:30 GMT, 1:30pm BST), with expectations centered on a headline print of 220k after last month’s “Twilight Zone” 223k reading. My model suggests that the report could exceed these expectations,with leading indicators suggesting a June headline NFP reading of 247K.

The model has been historically reliable, showing a correlation coefficient of 0.90 with the unrevised NFP headline figure dating back to 2001 (1.0 would show a perfect 100% correlation). As always, readers should note that past results are not necessarily indicative of future results.

nfpmodel8-6-2015 10-10-53 AM

Source:Bureau of Labor Statistics, City Index

Thus far, the “usual suspects” of leading indicators have painted a mixed picture for the labor market in July. Starting with the good news, the ISM Non-Manufacturing PMI Employment component saw its largest 1-month increase since records began, surging to 59.6, and initial jobless claims were at a 40-year low of just 255k during the NFP survey week. Unfortunately, it wasn’t all sunshine and roses for the other indicators: the ISM Manufacutirng PMI Employment reading dropped nearly three points to 52.7, while the ADP employment showed just 185k jobs were created last month. Taking the historical correlations into account, the weight of the evidence still supports an accelerating jobs market in the world’s largest economy.

Trading Implications

After surprisingly hawkish comments from Atlanta Fed President Lockhart earlier this week, many traders view September as a likely time for the Federal Reserve to start hiking interest rates. Therefore, the jobs report will be interpreted through the lens of monetary policy. Three possible scenarios for this month’s NFP report, along with the likely market reaction, are shown below:

NFP Jobs Created Likely USD Reaction Likely Equity Reaction
< 180k Slightly Bearish Slightly Bullish
180k-250k Slightly Bullish Neutral
> 250k Bullish Bearish

As always, traders should monitor both the overall quantity of jobs created as well as the quality of those jobs. To that end, the change in average hourly earnings could be just as critical as the headline jobs figure, especially after last month’s disappointing 0.0% growth in wages. If this figure moves back into the 0.2% range, it would strengthen the case for a September rate hike by the Federal Reserve. Historically, USD/JPY has one of the most reliable reactions to payrolls data, so traders with a strong bias on the outcome of the report may want to consider trading that pair.

Though this type of model can provide an objective, data-driven forecast for the NFP report, experienced traders know that the U.S. labor market is notoriously difficult to predict and that all forecasts should be taken with a grain of salt. As always, tomorrow’s report may come in far above or below my model’s projection, so it’s absolutely essential to use stop losses and proper risk management in case we see an unexpected move. Finally, readers should note that stop loss orders may not necessarily limit losses in fast-moving markets.

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