Today's "Max Pain" - A Stronger Than Expected Non Farm Payrolls Report

While normally quite absurd, we do have to admit that last month, Deutsche Bank's Joe LaVorgna was among the analysts closest to the final actual number, which came in far below consensus. As such we give him the benefit of the first forecast: Joe LaVorgna is expecting a headline/private payroll increase of 75k/80k respectively. The market is looking for 100k/110k. Unemployment is expected to hold at 8.2%. The irony today is that max pain is a far stronger number, which in light of some very recent economic news, can not be ruled out (see Nick Colas' discussion below): if indeed NFP rises by well over 100,000 the market will have to push back its prayer that the NEW QE will come in September into 2013 as Bernanke will not do another easing round just as the presidential election approaches. What are some others thinking? Here is what Bank of America says.

We forecast nonfarm payrolls to increase by 85,000, slightly higher than the pace of job growth in June. Initial jobless claims, which are the best leading indicator of job growth, have been noisy, given distortions from auto retooling. As such, it is difficult to get a clean measure of job cuts during the month. In addition, the ISM manufacturing and services surveys for July have yet to be released, which are an indication of how employers view employment trends. As such, there is less information available this month for forecasting payrolls. We, therefore, turn to our assessment of corporate behavior, which has appeared to turn lower. Earnings reports revealed more cautious corporations and sentiment surveys have deteriorated. 


We expect the government will continue to shed jobs. We forecast the three-month average drop of 15,000 in June. Private payrolls will, therefore, be up 100,000. In June, retail trade and health services were surprisingly weak. We, therefore, look for some bounce back in July, or perhaps a revision. Elsewhere, we expect the trend toward temporary hiring to continue. On the downside, construction hiring should remain weak and manufacturing job gains should slow, reflecting the weakening in production.


We forecast the unemployment rate to hold at 8.2%. After two months of gains in the labor force participation rate, we forecast a modest drop. This reflects discouraged workers dropping out of the labor force and the steady aging of the population. Looking further ahead, the labor force participation rate should partly reverse as the economy heals and discouraged workers return. 


With slow job growth and high unemployment, we expect wages to remain soft. We forecast average hourly earnings to only increase 0.1% mom in May, following the unexpectedly solid gain of 0.3% in June. This will push the YoY rate back down to 1.7% from 1.9%. In addition, we look for the work week to be unchanged, at 34.5.

What is curious is that for those who actually track tax withholdings, the data actually improved in the past month, confirming that if anything the likelihood is precisely of a Max Pain outcome, as more jobs are added than expected.

Here is ConvergEx' Nick Colas with his take:

  • After a swoon lasting several months this year, income tax and withholding payments to Treasury grew by 4.6% (adjusted for differences in calendar days) from July last year.  This comp is the same whether you include or exclude a large but often overlooked item on the Daily Treasury Statement entitled “Taxes not withheld” – those monies submitted by commissioned sales people who do not have their taxes withheld - real estate agents, for example.  This 4.6% growth rate is the best result since March 2012 (when the reported number of U.S. jobs added was 154,000. 
  • The accompanying chart shows that there is a clear correlation between the reported jobs data and the withholding/tax receipts. The general trend is that both peaked early-to-mid 2011, had a bit of a surge again in early 2012, but have been trailing off since then.
  • We scratched our heads over the unexpected strength in July 2012, and the only explanation we can really forward is that North American automobile production is up 2.8% in this July over the same month in 2011.  July is customarily a very slow time for the auto industry when it comes to running their domestic assembly plants.  Until a few years ago, it was common practice to shut down every plant in the country for the week of July 4th and the subsequent seven days  as well.  Now, with every auto company trying to maximize capacity utilization, July is increasingly a normal working month.  In July 2012, for example, North American automobile assembly plants churned out 868, 437 cars and trucks, up 2.8% from last year’s production.  Keep in mind that the auto industry works on a just-in-time basis, so when car plants operate, it means every supplier in the system has to run their plants as well. 

So are we seeing the U.S. economy get a “Second wind” with this positive tax/withholding data and its implications for the domestic labor market?  I would love to say “Yes,” but let’s fall back to “That would be nice.” If it was the auto industry that helped the Treasury data, then remember that yesterday’s monthly sales data was a pretty flattish 14 million unit run rate.  That’s where the industry has been selling for much of 2012.  And recall that dealer inventory levels are pretty healthy, so incremental production will need incremental sales later this year.

The larger issue, and the one I will close on, is what a better Jobs Report will mean to the Federal Reserve and the U.S. stock market.  Putting the problems in Europe on the side for a moment, this issue of economic strength/Fed action is the single most important question facing investors in U.S. equities.  For weeks, the roadmap has been clear:

The Fed needs to see a deteriorating economic picture in order to launch a new round of bond    buying/liquidity operations (AKA QE III).  The sooner we get that data, the sooner markets can rise again, since the last four years of market action shows that equities only increase in value during periods of Fed “QE.”

If our analysis is correct, the Fed and investors will face a bit of a quandary.  My sense is that one good number is actually not good news for stocks, since the entire economic “Recovery” from the 200-2008 Financial Crisis has been studded with short bouts of acceleration followed by relative stagnancy.  The Fed needs a weakening labor market to give them air cover for another round of QE, especially so close to the November elections.  One good Jobs report is enough to put them on the sidelines for the September FOMC meeting – not good news for an impatient market thirsty for more Fed liquidity