Friday, May 05, 2006

Strange Market Reaction to U.S. Labor Market Data

Sometimes financial markets react to news in a really irrational way. Case in point are the reaction to today's labor market report from the Bureau of Labor Statistics.

While it is true that employment growth was relatively weak, increasing only 138,000 versus the expected 200,000 (The household survey showed an even weaker increase of 47,000), every other number were extremely strong. For example, with average work week increasing from 33.8 hours to 33.9 hours, total hours worked increased 0.5%, which is very much for just one month.

Moreover, and perhaps even more importantly average hourly earnings rose by a full 9 cents to $16.61 and the March number were upwardly revised by 3 cents. Moreover, with hourly earnings increasing much faster in the labor intensive service sector than in manufacturing, this will have even stronger implications for consumer price inflation numbers.

This acceleration in wage growth, adding to the effects of soaring commodity prices and a falling dollar, makes a continued acceleration in consumer price inflation almost certain.

Given this, you should expect at least bonds to fall (the effects on stocks of such data are more ambigous as they will benefit to the extent this kind of strong numbers indicate higher growth). But no, instead both bonds and stocks rallied, even though not even traders who only read the news media reports about this could hardly have missed the average hourly earnings number.As the CNN Money story puts it: "Bond investors have been concerned that the strong labor market will drive up wages and increase inflationary pressures, but on Friday they seemed to focus on the softness in the overall payroll number.". A highly irrational focus as the reason why the Fed would care about payrolls are in its effect on wages (and by extension prices).

Of course, the traders who buy bonds on these kind of irrational premises are bound to get punished when bond prices later fall, as price inflation data will show continued acceleration which in turn will force the Fed to tighten even more. That in turn of course creates an opportunity for people who are in a position to go short on bonds to do so and so make money from today's irrational market reaction to the U.S. labor market data.


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