A Recurring Pattern In The Labor Market May Show That The Economy Is Weaker Than We Thought
On Friday, nonfarm payrolls numbers came right in line with expectations, but private and manufacturing payrolls both surprised to the upside. Later that day, ISM's monthly services index got an unexpected boost from the employment sub-component, which surged to 56.3 from November's 50.3 reading. On Thursday, ADP's monthly payrolls report blew by expectations. ADP says 215K private-sector jobs were created in December, well above estimates of a 150K gain.
The big question is what all of this means for the market.
Last week's release of the FOMC minutes from the Federal Reserve's latest monetary policy meeting in mid-December – in which it was revealed that several members of the Committee favored ending quantitative easing sometime in 2013 – has investors paying even closer attention to the employment data than before.
Deutsche Bank's Joe LaVorgna explained the new importance the employment statistics have taken on for markets in light of the revelations in the FOMC minutes. In a note to clients following the release of the minutes, he wrote, "In other words, this should significantly amplify the financial market's sensitivity to upcoming economic data, particularly if we witness a spell of robust economic reports which could bring into question the perception of the Fed's exit strategy."
Now, just when investors and Fed-watchers are becoming laser-focused on labor market data, trying to glean clues as to the Fed's next move (i.e., when they will slow or stop asset purchases), the statistics may become a whole lot less reliable.
In a note to clients this morning, Citi economist Steven Wieting highlights the seasonality effects on labor market data that have dogged investors at the beginning of every year for the past three years.
Wieting suggests that exaggerations in the data over the coming months are likely to reignite the debate surrounding the economic recovery in the United States. That could be a major headache for investors trying to figure out when quantitative easing might end and what effect it will have on markets.
Wieting writes:
As a small background issue, we also suspect a dampened but still-evident pattern in which winter and spring employment data may prove a misleading guide to the strength of the expansion.
Gross hiring and firing — labor market turnover — was recently still just 80% of the pre-downturn pace. While seasonal adjustment factors are adaptive, it’s a slower process than many understand. A recovering housing sector would suggest some return to higher “seasonality” in employment patterns.
However, some exaggeration of strength during seasonally weak months (January for example) and exaggerated weakness during the usually stronger unadjusted months (April) is still quite possible for a fourth year in 2013 in the keenly watched employment data.
This has driven conflicting views of the strength of the recovery in each of the past three years, and suggests a straight line performance in stock and bond markets is unlikely this year as well (see figure 11).
Below is the Citi Economic Surprise Index, which plots the difference between actual economic data and the consensus estimates for that data before it was released. When the index is above zero, economic data is coming in better than expected.
The point about seasonality Wieting is making is illustrated in the chart. 2010, 2011, and 2012 all started the year positive before plunging into negative territory, meaning economic data began coming in weaker than expected.
If recent history is any guide, it might be a good idea to pay attention to these seasonality effects when interpreting the employment statistics in the coming months.