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February payrolls report still more important than usual

Thu, Mar 8 2007, 15:28 GMT
by KBC Market Research Desk

KBC Bank

• Recent correction in equity markets ups the importance of the February payrolls
• Payrolls may have been negatively influenced by the weather
• Risks seem to be on the downside of expectations though

Why are payrolls so important?

The US payrolls report is traditionally the most influential data release for financial markets. It gives a very timely and comprehensive view of developments in the most important economy of the world.

It shows how activity fared in various sectors (retail, services, housing, manufacturing). Combining payrolls and hours worked, it gives a rough estimate of growth. It contains indications about wages (and so inflation) and, of course, allows measuring the tightness of the labour market.

All these and other elements together also allow to judge how monetary policy may evolve further out.

The February report may be still more important, as currently the markets of riskier assets, are very shaky. While a re-assessment of risk is probably the main factor behind recent corrections, there are re-surfacing doubts too on the outlook of the economy and the kind of landing we may expect. Should the report point to increased risks of a harder landing, the recent correction in risky markets may get a second leg. On the other hand, a strong report may ease these fears, but is problematic for bonds that profited so much in the recent correction.

What partial indications are available?

The most important factor may turn out to have been the weather conditions. In the previous months the weather has been un-seasonally mild (warm and dry) and so favourable for the economy and the labour market, but in February, the weather turned unfavourable (cold and wet). This change in the weather between the January and February survey weeks might have affected activity in a number of sectors negatively.

The construction sector is the first that springs in mind.

Construction payrolls rose by 22 000 and 10 000 in January and December at a time when the number of houses under construction fell. While non-residential investment is doing well, these figures are clearly upwardly distorted by the weather. So a sharp pull back in construction payrolls in February is likely, as also the underlying trend in housing is sharply down. There may also be a weather-negative effect in professional & business services and its subgroup of temporary help agencies that performed (too) good recently.

Besides the weather-related part of the story there may be some genuine trend-like slowing in employment growth.

Despite a somewhat better ISM survey, it is clear that the sector is having problems and that should result in another drop in manufacturing payrolls of slightly less than 20 000, about the number of job losses in previous months. There may be some upside risks to these expectations as the ISM employment index edged up to 51.1 from 49.5 previously.

Forecasters are looking to some partial labour market indications for clues about the payrolls results.

The relevant initial claims results show a sharp rise of the initial claims between the January (287 000) and the February (331 000) survey weeks. Maybe more important, the continuing claims rose about 160 000 in the same interval.

The strike activity data show that about 2800 workers started to strike in February, not so relevant in the broader context.

The Non-manufacturing ISM employment index edged marginally higher to 52.2, but more importantly it remains at low levels.

ADP employment report points to weakness

The ADP report showed private sector employment increasing by 57K in February below the expected 100K and below the downwardly revised increase of 121K in January.

This may point to a rather weak Payrolls report on Friday, even if one takes into account that the ADP report makes abstraction of payrolls growth in the public sector, which is usually good for 15-20K job growth. As such, the ADP report is consistent with a Payrolls report of about 75K, which is still below the current Bloomberg consensus of 95K.

Other details in the report

While the payrolls are the most important part of the report, market reaction may be coloured by a number of other data from the report. The unemployment rate should stabilize at 4.6%, after moving higher in January. The cyclical low of 4.4% was reached in October 2006. While a gradual rise of the unemployment is likely, it is unlikely there would again be a rise this month.

The underlying trend in average hourly earnings is about 0.3% M/M, but in January they rose only 0.2% M/M, but this followed a 0.4% M/M increase in December. So, the most likely result is a 0.3% M/M increase. However risks are on the upside, as the weather-related loss in payrolls might disproportionally affect lower paid workers, pushing the average higher.

Forecasters struggle with February payrolls

Forecasters have traditionally done a bad job in forecasting the February payrolls. The standard error has been the largest on the entire year, even surpassing the January month, also a difficult one. Weather is the most likely culprit. In the past, most of the time payrolls came in above consensus, but since 2000, there were three large below consensus and four small above consensus outcomes.

Conclusion and market reactions

The consensus estimate of 95 000 is slightly below January’s 111 000, with the complete range between +40 000 and +150 000. There are some reasons to put the risks on the downside. The consensus expects the unemployment rate to be unchanged at 4.6% and average hourly earnings to be up 0.3% M/M. We have no reasons to deviate from consensus on these.

Equity markets could use a decent number to put its woes behind and establish gradually a better sentiment. At this stage, interest rate considerations seem to us less important than usual. So in case of a weak figure, equities might have a difficult time, even if interest rates go lower.

Regarding currencies, there looks to be an asymmetrical risk. A weaker payrolls report should do more harm to the dollar than a good report might benefit it. Especially for USD/JPY, we are interested to see whether a weak report might push the pair below 115.16. This might trigger another round of unwinding of carry trades.

Bonds had a strong run recently and so need a weak figure to safeguard these gains. Whether there is already much upside will probably depend on equities. If these fall sharply, there might still be some more upside. If not, then a weak report should lead to only moderate gains. For the June Note future, the highs at 109-18+ or the 4.40% on 10-year yields looks a hard nut to crack and a test might generate some profit taking. A steepening of the curve is more likely.

In case of a strong figure, we might get some decent profit taking.

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Published on  Thu, Mar 8 2007, 15:36 GMT

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