Economic releases and how the market reacts

By John Becker

Topic of discussion: Employment situationPublished 4:30pm September 4th

All graphs in this report will be provided at full size in Appendix 1-6

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Surface view of the September 4th Friday employment report.

John Becker

This morning an hour before the markets opened for the day the Bureau of Labor Statistics released a situation report on US employment. This report gave us lots of insight into how the economy is doing and the direction it is heading by looking at different aspects of employment in the US. The statistics in today’s reports ultimately were controversial there was good news and bad news, both of which need to be weighted, to see what the economy is doing so we can decide what the markets will do with this news.

So what are the important numbers? Well in my opinion there were three highlights that jumped right off the page and told a very clear story individually.

There was an estimated nonfarm payroll employment increase of 173,000 jobs created. This was the bottom of the barrel so to speak because the consensus range (range that

was considered the estimate of how many jobs would be created) was from 173k to 257k jobs. So at face value this is not good news.

The unemployment rate dropped to 5.1% This is a good, or to be honest a great number, because the consensus was for the rate

to maybe drop to 5.2%, however it exceeded the consensus and had a substantial drop. This means more people found jobs that were wanting to find jobs.

The participation rate stayed steady at 62.6% This is a low number, but it was just as low the previous month so it gives us positive

data. This rate tells us that since it did not change, but the unemployment rate decreased, more people found jobs that were looking for jobs before and were already calculated in the participation rate. So coupled with the unemployment rate this number is a positive statistic.

To simplify, the two major factors of this employment situation report was the Jobs report and the Unemployment rate (when coupled with participation rate).

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The good, the bad, and the economically stable???

What do the numbers mean?

Jobs Report

The jobs report as stated in the introduction to this report was at the minimum consensus. This does not bode well for economic growth; however there is a silver lining in the fact that the August estimates are historically underestimated. August is a month in which you can look at the data from the Bureau of labor statistics and see that they are constantly revising this number upwards.

In 2011 the number of jobs estimated was revised from 0-57-104k for August.

2012: 96 - 142 -192k

2013: 169 – 193 -238k

2014: 142 – 180 -203k

Chances are probable that this month’s 173k jobs will be revised upwards making it not such a terrible number if you consider revision.

What does this number mean for the economic climate?

This is definitely not the kind of number you would march up to the Federal open market committee and state that there is no way they can deny the economy is growing because of this figure. It also however does not give the impression of a weak economy that would cause the FOMC to not even consider a rate hike. This number by itself is very much a neutral

figure. Bill Gross even goes as far as to state in an interview for CNBC that “The jobs number was mediocre, but decent, and probably in terms of Janet Yellen and the Fed, sufficient for either September or December.”

What would you expect this number to do to the market?

This month’s employment report was an oddity in the sense that the effect of the employment report on the market would not mirror the effects of the last few months or even the last year, because this September on the 17th the FOMC will be deciding what they are going to do with Interest rates based on the wellbeing of the economy.

To put it in perspective, normally a good economic outlook is great for the markets because it shows investors that companies are doing well and this forecasts that companies will continue to do well in the near future. This means that good employment report = rally in the market.

This month however this good employment report could cause the FOMC to see an opportunity to raise interest rates, which could end up causing adverse effects on the market.

Today’s employment report was as stated before a big deal because it is so close to the FOMC decision date.

So what exactly happened today when these numbers arrived? Well before I talk about the way the jobs report

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affected the market let’s talk about what the Unemployment rate decrease so we can tie the two together and see the collective effect on the markets.

Unemployment Rate

The unemployment rate was estimated at 5.1% which is the lowest rate since April of 2008.

(You can find an enlarged version of this graph in the index of this paper.)

So what does such a low unemployment rate mean? It’s basically telling us that people wanting jobs are getting jobs, and this lets us know that the economy is showing signs of strength. People want to work when the economy is

thriving.

What does this number mean to the Federal Open Market Committee? The FOMC could see this as a good

economic indicator because the Federal government sees a rate of 5.1% as pretty close to full employment. Perhaps this figure can lead the Fed to find reason for rate hike.

What would you expect this figure to cause the market to do? Normally a good Unemployment rate would lead investors to believe that economy is going to thrive, meaning companies are going to hopefully grow, and ultimately driving up security value. However this might not be the case this month because like I have stated time and time again, the FOMC will be using this figure along with plenty of other statistics to see if they should hike up (raise) the federal funds rate.

What exactly happened today with the release of the Unemployment rate?

As stated before there is no way we can see the effect of just the employment rate on the market this month because the number of jobs created changed from last month? There is no way to examine the sole effect of one unless you have one figure held constant. So in the next section of this paper let’s examine what the market did today, and what it has done in the past

during previous rate hikes.

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What was the effect on the market?

We are going to examine the market in a few different ways:

For one we are going to look at the way the S&P 500 moved today, and also how the Futures market for the S&P moved.

Secondly we are going to look at how the S&P moved in the past when the Fed raised rates.

Thirdly we are going to do the exact same analysis that we do for the S&P and mirror it for the Credit or Fixed income market by examining the 10 year US Treasury Bond.

Lastly we are going to look at what happened to the US dollar, so that we can determine what the opinion on Inflation in the market is.

How did the S&P 500 move today?

The S&P market did not have any great change today; you can see this graph in the next column over that shows that when the market opened there was a significant drop in the index price because people were not satisfied with the report.

Is this a normal reaction to an employment report? Well sure if the employment report was bad; however this wasn’t exactly a

horrible report. It was not the best report of the year, but is this drop in price justified?

I don’t believe that this is a justified drop in price based solely on the employment report numbers, I am willing to bet that the reason the market reacted this way is because we are in a sort of lose, lose situation. If we don’t see growth the market will dive because investors want growth. Alternatively if the economy is growing the fed might raise rates causing the market to dive as well, so there is not many ways around the market making a short term fall.

How did the Credit market move today?

The credit market had slightly more movement from today’s report than the S&P did;

We had over a 3 basis point move which is honestly a pretty large move for the 10 year treasury yield, meaning prices were dropping today.

So was it the numbers from the jobs report that moved the credit market

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and the S&P today or was it the underlying affect the numbers could have on the fed’s rate decision?

Well let’s look at the S&P500 in the past when there were significant rate hikes. And then let’s look at how the 10 year treasury did in during those same dates.

First here is a graph of the Federal funds rate history:

The Two large rate hike dates I want to look at are the hikes from:

1972–1974 1977–1980

From 1972 to 1974:

The Fed hiked up rates and it caused movement in the credit market big time;

Yields crawled upwards causing bond prices to go down meaning it was a bad time for fixed income investors.

What did the S&P do during this rate hike?

It doesn’t look like the market fell nearly as hard as bond prices.

This seems very similar to what we observed today in the markets let’s check the next rate hike and see If we get similar results.

Let’s look at 1977 – 1980

The rate hike in 77 caused a similar increase in 10 year Treasury bond yield over the three year period;

This is another large leap in 10 year treasury yields, indicating trouble in the credit market, and falling bond prices.

And the S&P?

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The movement of the market actually trended in the opposite direction, but what you should look at is the fact that the movement itself in both Federal fund rate hikes, were very small and almost horizontal, while the credit market (10 year Treasury bonds) had an obvious climb in yields.

What does this tell us?

The first thing that pops out to me about this information is that when the Fed has raised rates the market has historically moved just like it did today in different scales. This signals to me that the employment report was seen as a good report in the eyes of investors, so even despite their small 30% consensus on a rate hike;

The markets are acting just like they would if rates were going to rise. Will the fed raise rates on September 17th? Well that

question cannot be answered with just the employment report, but what I have demonstrated is that investors seem to be putting out rate hike vibes.

One more thing I would like to comment on for today’s Employment report affect is the exchange rate between USD and the Euro. Exchange rates can be good leading indicators for inflation and the fed moving rates is closely correlated to inflation expectations.

I don’t want you to feel like this report is deviating from the Jobs report and becoming more of a fed funds rate hike prediction, but today’s report is so closely tied with the fed decision in September that we have to think about things from the fed’s perspective.

So what did the exchange rate do?

It opened and closed with very little movement, only a slight strengthening of USD. This could be telling us that even with the good employment report there is not much risk of inflation. If there is no inflation the fed will perhaps not see raising rates as a suitable action to take. Now I don’t have a lot else to say on the USD exchange rate other than the fact that the employment report did not move it substantially which could show the fed that even though the

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economy might seem strong, people are not inflating it so there is a case against raising rates right there in front of them.

Final thoughts and a quick Recap:

The employment report was one to watch this week. So much uncertainty in the market, people needed something that they could use to calm their anxiety. The employment report was not the answer however. There was not a one sided story that it told. The jobs added was not a good number (with revision it’s not bad), but the Unemployment rate hit a long time low.

There is a large balancing act of reasons for the fed to raise rates and reasons for the fed to not raise rates in every investors mind right now, and the employment

report did not do much to tip the scales heavily in one direction.

When I did research into past rate hikes however I did find that the market reactions today did slightly mirror past hikes, so it could be argued that the market consensus is for a rate hike.

Once again, however, if you look at the movement of the USD though there is not a lot of evidence of inflation though so there is a case against the rate hike.

It is anyone’s guess on what the Fed will do in September, but hopefully this report on the employment situation can come in handy when you need to make a case for either side of the argument.

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Appendix 1

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Source: Bloomberg

Appendix 2

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Source: BOLS

Appendix 3

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Source: Yahoo finance

Appendix 4

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Source: Yahoo finance

Source: Yahoo finance

Appendix 5

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Source: Yahoo finance

Source: Yahoo finance

Appendix 6

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Source: Yahoo finance

Source: Yahoo finance

Source: Bloomberg