On Friday, we’ll see the Department of Labor’s unemployment report for August.
Officially, the focus is on employment rather than unemployment. Unofficially, it’s the unemployment rate that generates the most interest.
It’s likely to be a big day for stocks. Typically, the S&P 500 is three times more volatile than average on report days. Because volatility is tradable, analysts put a lot of effort into forecasting the report.
Some analysts use the government’s own data to generate a forecast. They use data like we see in the chart below. The chart shows the year-over-year change in payroll tax receipts.
This includes money employers withhold from employees and then send to the government. If employment is increasing, tax receipts should be growing. The chart shows that’s not what’s happening.
At the end of August, employers were making smaller payroll tax deposits. This means employment numbers are weak.
There are many reasons tax receipts dropped in August. It’s possible low-paid, younger employees replaced retiring older workers. Or employers might have cut hours of part-timers.
We know taxes didn’t fall because of robust employment growth.
The good news is the change is relatively small. There’s probably no significant change in the unemployment rate.
But the decline in revenue comes at a bad time for the government. It’s likely we’re looking at a larger-than-expected budget deficit for the fiscal year that ends in September.
Remember, government expenses will rise to cover the costs of recovering from Hurricane Harvey.
Harvey is also likely to reduce tax receipts even more. The storm forced businesses to close, and many will remain closed for some time. Payroll taxes will drop further as lost wages add to the suffering in the region.
This data means the Federal Reserve remains trapped. It can’t raise rates when the Treasury needs low rates to finance the deficit.
Harvey strained a fragile system that was already under stress. It’s important to watch the Fed for signs of how it’ll respond.
If the Fed stays with its plan to begin quantitative tightening this year, it will probably trigger a recession. If the Fed cuts rates, it might send the stock market into a panic.
Michael Carr, CMT
Editor, Peak Velocity Trader