There are two mandates under which the Federal Open Markets Committee (FOMC) must operate. First, they must strive to maintain a rate of inflation at the 2% level, and second, they must maintain the U-3 unemployment percentage below 5%. The primary lever used by the FOMC to influence inflation and unemployment is the target range for the Fed Funds interest rate, currently set to a range of 0.50% to 0.75%.
One of the principle drivers of inflation is wage growth. Since inflation currently sits at 1.7% and sloping upward, FOMC will scrutinize the rate of wage growth that is reported in the two employment reports issues this week. Wages are directly impacted by the employment situation (they are, after all, a classic supply and demand function,) which is another reason the Jobs Report is so closely monitored.
The key statistic being watched in tomorrow's release is ADP's employment estimate for December, 2016. The consensus estimate is for 172,000 jobs being added in December, down from the 216,000 added in November, and well off the 306,000 added a year ago.
|ADP Employment Change through November 2016|
|US Inflation Rate through November 2016|
It normally takes about six months for a change in monetary policy to be reflected in the key economic indicators. When FOMC raised rates in December, they did so anticipating the rate of inflation and unemployment in the June 2017 time-frame. The challenge before the committee now is to anticipate what impact that rate increase is having, if any, and then determine when the next increase is best served such that economic growth is maintained, but is not allowed to accelerate out of control. It's a bit of a balancing act, since moving to much too soon will force the economy into a contraction, and that's not at all the objective.
Pay attention to tomorrow's number, but realize that the more meaningful report is issued Friday. We're using tomorrow's number as the gauge to determine how close the current consensus estimates for Friday will be to the actual release. What matters to us as traders is how the market may adjust to these numbers in the short term. Multiple strong releases will pull the next interest rate hike closer to the March or May FOMC meetings, and that will require market adjustment. That adjustment, of course, creates prime trading opportunities since we'll want to catch those short-term moves.