Prepare for a do-or-die jobs report
You don't have to be a hedge fund trader to get excited, and maybe a little nervous, about this Friday's jobs report.
To understand why the U.S. Labor Department's initial job reading this week is so important, given that we get an update on the unemployment rate and payroll gains each and every first Friday of the month, you've got to understand what's at stake: Whether or not the Federal Reserve slows down its ongoing $85 billion-a-month bond purchase stimulus.
The central bank's "quantitative easing" program, colloquially dubbed QE3, was announced in September 2012 and has helped fuel recent market gains. In fact, by one measure stocks are growing increasingly and worryingly dependent on the Fed's monetary morphine drip.
Since the bear market ended in early 2009 -- when the first round of bond purchases was launched and Fed Chairman Ben Bernanke started subsidizing government borrowing -- the relationship between the S&P 500 and central bank's monetary base is an incredible 87 percent.
That is, changes in the Fed's money supply account for 87 percent of the changes in the stock market. By comparison, in the four years immediately preceding the bond-buying binge, that figure was 36 percent.
Since May, when Bernanke first start dropping hints that QE3 could be slowly rolled back -- baby steps toward finally ending the program -- the market has been shaky, responding to every rumor, hunch and innuendo about whether the flow of cheap money will continue. Even talking about tapering was enough to push interest rates up by a third and slam the brakes on the housing market, as mortgage rates climbed from 3.4 percent to 4.6 percent between May and August. Stocks were also hit.
Ever since then, the market has tended to react badly to strong economic data, betting that this accelerated the Fed's time-table for scaling back bond purchases. Likewise, it has rallied on poor economic news, assuming that any weakness could delay the day of reckoning when the Fed would begin withdrawing stimulus.
Stocks revealed their increasingly schizophrenic nature on Wednesday, dropping at the open on better-than-expected private-sector jobs data from ADP, but falling on weaker-than-expected results from a survey of non-manufacturing activity. Specifically, ADP showed that U.S. businesses added 215,000 jobs last month, above the 185,000 increase analysts were expecting and representing the third consecutive month of accelerating gains.
To normal people, this seems backwards. But in our current reality of ultra-dependence on central bank liquidity, the twisted logic makes sense.
Here's why: The financial markets have disconnected from the economic fundamentals in a big way. By one measure, looking at the market versus GDP growth estimates for 2013, the break happened back in 2011. Back then, analysts were looking for full-year growth of nearly 3.25 percent. Now, the estimate is all the way down to 1.7 percent.
Other down-to-earth metrics, be it growth in personal consumption expenditures or the growth in full-time employment, have also rolled over. Yet the S&P 500 has climbed from around 1,300 then to nearly 1,800 now.
The kicker has been central bank stimulus, which has taken the Fed's monetary base from around $800 billion before the financial crisis to nearly $3.7 trillion.
If the government-reported payroll gains are as strong as the ADP numbers suggest, it will provide added impetus to taper. It will also stoke fears that have been nagging at the market since the Fed's account of its October meeting suggested Bernanke and company are nearing a decision on tapering "in coming months," with most officials wanting definitive signs of economic improvement for dialing back on stimulus.
In other words, the threshold for tapering is being lowered as the Fed grows increasingly nervous about the rising risks of continuing the program unhindered.
If all this sounds seems like economic divination, well, that's because it is. No one really knows what the handful of souls on the Fed's Open Market Committee will decide when they meet later this month -- with major consequences for the price of money, the housing market, the stock market and the job market in the months to come.
Friday's payroll number will represent the final and most critical hard data point of the year before the Fed's policy statement on December 18. With a market overextended and overly reliant on QE3 stimulus flow, that's why it's so important.
Buckle up. It's going to be a wild ride.
