Traders Game Fed Reaction to Nov. Jobs Number

The stock market's year­-end rally could be put to the test even before the release of Friday's nonfarm payrolls, as traders game the Fed's possible reaction to the number.

In the coming week, the November employment report looms large since it is viewed as the most important piece of data available ahead of the Federal Reserve's meeting Dec. 17 and 18 and therefore could be a major catalyst steering end­ of ­year trading.

"We're getting the true test," said Art Hogan of Lazard Capital Markets. "A good jobs number and a positive reaction in the market is exactly where we need to be, but I think we're still in the phase where good news is probably bad news. If we get a blowout number, that will give people some pause as to whether there will be a taper in December."

Besides the employment report, a number of economic releases are due in the coming week, including third­quarter GDP on Thursday and auto sales Tuesday.

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Stocks closed out November with strong gains. The S&P 500 rose to 1,805, up 2.8 percent for the month and 26 percent for the year. The Dow and S&P ended the week near highs, and the Russell 2000 finished at a new closing high of 1,142. The Nasdaq was at a 13­-year high of 4,062 and is still about 20 percent from the intraday high of 5,132 in March 2000.

Since the 1900s, December is the best month for the Dow and the second­best month for the S&P 500 and Nasdaq. Historically, all three indexes gained on average between 1 and 2 percent, respectively.

Hogan said there could be some profit­ taking in the week ahead, as traders position for the possibility that the November jobs number is better than the 185,000 expected. "I think there should be," said Hogan.

"Everybody's been talking about taking profits for months now, and it hasn't happened. … This is kind of a generational kind of year when you have high 20 percent returns across all of the major indices. The flip side of that is how many professionals beat the market benchmarks. Some of what you're seeing is performance­ chasing."

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October's report of 204,000 nonfarm payrolls was well above expectations and helped drive speculation that the Fed would begin to pare back, or taper, its $85 billion­-a-­month bond­ buying program sooner than expected. The unemployment rate is also expected to fall back to 7.2 percent from the 7.3 percent reported for October.

"We'd expect the favorable momentum that we've seeing in the past few months to continue into November," said Dean Maki, chief U.S. economist at Barclays. "We've been averaging roughly 200,000 jobs per month over the last few months, and there doesn't seem to be anything pointing toward a weaker report. … The rise in the unemployment rate last month we attribute to the government shutdown, and we expect it to go away."11/30/13 With jobs number on the horizon, some sellers could emerge.

Maki does not see the Fed deciding to taper in December. "Based on what the Fed's been saying, we think that it would take a very robust report for the Fed to taper in December. And the reason is that Vice Chair [Janet] Yellen said they need to see evidence growth is picking up before they taper, and there's no evidence of that at this point. Our tracking estimate for Q4 at this point is 1.7."

But Joseph LaVorgna, chief U.S.economist at Deutsche Bank, said the quarter could be stronger than many believe, and the Fed could move toward tapering in December. "In light of the better­ than ­expected Chicago PMI, better­ than ­expected claims, better ­than ­expected sentiment, it seems to be the market is starting to think that maybe the data over the next couple of weeks is going to be better than expected," he said.

LaVorgna expects to see job growth of 185,000 and upward revisions to the past two months of 50,000. "There's more evidence the labor market is improving a bit. This is not a great economy but things are getting better," he said. "The path to least resistance is probably higher equities, higher bond yields. If we get the numbers right, the Fed could be tapering in December."

He also projects a higher trajectory for GDP. He expects third ­quarter GDP to be 3.2 percent when revisions are reported Thursday, but he also expects the fourth quarter to come in above expectations at 3.5 percent. The third ­quarter GDP was reported at 2.8 percent, well ahead of expectations on a surprise surge in inventories.

The question is whether the markets have priced in a taper in December, and analysts appear split since there is a group of Fed watchers that expect tapering in January or March. Tom Simons, money market economist at Jefferies, expects to see 205,000 November nonfarm payrolls, at the top of the range. "If our forecast is realized and we get another 200,000­-plus read on payrolls, and we get a reversal in unemployment back toward 7.1 percent, then there's a real chance we could get tapering in December," he said.

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As for the market, if third ­quarter GDP is far above 3 percent, Simons expects the bond market to sell off and rates rise. If jobs are over 200,000, "yields would be considerably higher because many more people would be backing that taper camp," he said. Tapering is being somewhat priced into the bond market, with the 10-­year Treasury yielding 2.75 percent Friday, way above the 2.62 percent at the beginning of November.

But the two­-year note was at a yield of 0.28 percent, after starting the month higher at 0.31 percent. Simons said the lower yield on the short end of the market reflects the Fed's campaign to assure markets it is not planning to raise short­term rates any time soon, even if it does taper back bond­ buying.

The asset purchases, or quantitative easing, are credited with driving money into the stock market though there is disagreement over how much of the market's gains came as the result of Fed programs. "On the [tapering] announcement, both markets could be shaken up a little, but in two to three weeks, things will be back on home base," Simons said. "If they do taper in December, by the end of next year, they still will have bought another $500 billion worth of bonds."

The ballooning Fed balance sheet will continue to be the tool it uses to pressure interest rates for some time. As securities mature, the Fed is replacing them with new asset purchases, in addition to the QE program. With jobs number on the horizon, some sellers could emerge.