MacroScope

As traders and economists hash over the sharp and unexpected drop in the U.S.jobless rate to 7.8 percent, they might do well to review some key data points that offered early hints that at least some households were seeing improvement in the labor market. Wall Street analysts in a Reuters poll had forecast a rise in the unemployment rate to 8.2 percent.

Even as big companies were laying off more workers or at least holding back on hiring, The Conference Board’s consumer confidence data showed workers felt more encouraged about finding jobs. The Thomson Reuters/University of Michigan survey depicted a late summer upturn in consumer mood even as gasoline prices remained high. The latest ADP report, with all its perceived flaws, indicated a consistent, moderate acceleration in hiring among small- and mid-sized companies since late spring even though big firms seemed reluctant to expand their payrolls.

The graph below shows confidence improving as job prospects brighten.

Ellen Freilich contributed to this post

The Fed did the twist. Will it shout as well? There has been some debate among economists about whether the U.S. central bank might launch a third round of outright bond buys or QE3 given that it just prolonged Operation Twist.

But a truly grim report on the U.S. manufacturing sector from the Institute for Supply Management, if coupled with further evidence of a deteriorating labor market, could certainly induce policymakers to press their foot to the monetary accelerator.

Not only did the index slip below 50 in June, pointing to a contraction for the first time in three years, but the reading of 49.7 was lower than the lowest forecast in a Reuters poll of economists. Moreover, the subcomponents showed the biggest drop in new orders since the aftermath of the Sept. 11 attacks in 2001.

Weekly data on applications for unemployment benefits have gained renewed importance since a weak March payrolls number left economists wondering whether a tentative labor market recovery was about to cave again. The last two weeks’ readings were just soft enough to leave investors thinking the country’s unemployment crisis may not be healing very quickly.

Daniel Silver at JP Morgan has dug deeper into the claims figures and found a curious trend: a repeated and distinctive tendency toward upward revisions in the numbers.

There has not been a downward revision to the initial claims data reported for the prior week since the start of March 2011, and this recent streak is not a new phenomenon—there have been upward revisions in about 90% of the weekly reports since the start of 2008, as well as going back even further to the start of 2000. These revisions are relatively minor (usually adding only a few thousand claims) and do not change the broader trends in the data, but they can lead to the weekly claims reports showing decreases to the more recent levels, whereas if the prior week had been unrevised, the reports would have shown increases in claims.

Phew. Industrial production rose 0.9% in July, the fastest in seven months. For the moment, that appeared to forestall fears that another U.S. recession  might be imminent, even if stocks were down on worries about weak economic growth in Germany. Harm Bandholz at Unicredit saw the figures as a bright spot:

Today’s report, in combination with the recent improvements in initial jobless claims and retail sales, corroborates our view that GDP growth in the second half of the year is likely to accelerate to (a still low) 2%-2¼% from less than 1% in the first half.

Economists at Credit Suisse were less sanguine:

The July industrial production performance is not consistent with recession.  But industrial production tells us where we are, not where we are going.

Five things to think about this week:

APPETITE TO CHASE? 
- Equity bulls have managed to retain the upper hand so far and the MSCI world index is up almost 50 percent from its March lows. However, earnings may need to show signs of rebounding for the rally's momentum to be sustained. Even those looking for further equity gains think the rise in stock prices will lag that in earnings once the earnings recovery gets underway, as was the case in past cycles. The symmetry/asymmetry of market reaction to data this week -- as much from China as from the major developed economies -- will show how much appetite there is to keep chasing the rally higher. 

TAKING CONSUMERS' PULSE 
- A better picture of the health of the consumer will emerge this week as U.S. retailers' earnings coincides with the release of U.S. July retail sales data and the UK BRC retail survey comes out on the other side of the Atlantic. With joblessness still rising, the reports will show how willing households are to spend and whether deep discounts, which eat into retailers' profit margins, are the only thing that will tempt them to shop -- both key issues for the macroeconomic and corporate outlook. 

CENTRAL BANK WATCH 
- After last week's Bank of England surprise, all eyes turn to what sort of signals the U.S. Federal Reserve and Bank of Japan will send on the outlook for their respective economies and QE programmes. After the BOE's expansion of its QE programme the short sterling strip repriced how soon UK rates would rise. But the broader trend recently in the U.S., euro zone and the UK has been to discount rate rises in 2010 -- and possibly as soon as this year in Australia. Benchmark interbank euro rates have risen for the first time in two months, and central bankers everywhere, including China, face the delicate balancing act of managing monetary tightening expectations in the months ahead. 

Market economists are taking a pasting worldwide for not predicting the global financial crisis. But how good is the profession at more bread-and-butter tasks, such as forecasting economic data?

In Australia, Reuters surveys 15-25 economists ahead of each quarterly CPI figure. A check back over analyst forecasts for the past 17 years shows:

the median forecast mostly gets the direction right, but tends to miss the highs and lows of the cycle the median forecast is pretty close about half the time but about a quarter of the time it’s well off the mark and of those — about 10 percent of the time — it’s not even close 

Forecasts matter because financial markets closely watch surveys of analyst expectations for major data, and the consensus forecast is priced into the market well before official figures are released. So any big swings in the exchange rate or bill prices on the day are usually due to whether the result matches expectations, rather than the figure itself.

Five things to think about this week:

EYE ON CENTRAL BANKS
-  Investors will be on the lookout for any further signals on quantitative easing when the European Central Bank and the Bank of England announce their decisions on Thursday. Analysts see the ECB leaving rates on hold but pushing ahead with and possibly extending a plan to buy up to 60 billion euros in covered bonds. The focus will also be on growth forecasts for the next year and the message they send about the pace of any recovery.

COMMODITIES SUPERCYCLE, CYCLICAL SURGE
- Oil prices are nearly double their four-year low set in December and the Baltic Dry Index, which tracks rates to ship dry commodities, has risen more than 300 percent since the start of the year. Coupled with a weakening dollar, investors might be bracing for the return of the supercycle in commodities. The resultant inflationary pressures could push investors away from government bonds and into the arms of equities.

EMERGING DISCONNECT
- High-yielding emerging market currencies remain weak, weighed down by poor domestic growth prospects even as emerging equities rise along with their developed market peers, buoyed by hopes of a global economic recovery. The disconnect is likely to persist with governments, particularly in emerging Europe, looking likely to lower interest rates further.

Markets might have rallied on relief that the jobs data this morning wasn't worse than expected, but there's no getting away from the fact that an 8.5 percent unemployment rate is an ugly number. The March jobs figures showed U.S. employers slashed 663,000 jobs in March. The unemployment rate was the highest since 1983. Here is some reaction from the market:

ROBERT MACINTOSH, CHIEF ECONOMIST, EATON VANCE CORP, BOSTON:
"It's telling you we're in a deep recession and it's still going to be a while to get out of it, especially on the employment side of things. But you have to keep in mind that this is a lagging indicator, we're going to get bad employment numbers, along with the employment rate, even if the economy is starting to turn."

PIERRE ELLIS, SENIOR ECONOMIST, DECISION ECONOMICS, NEW YORK:
"The report does not contradict the growing notion that the economy is finding a bottom. Employment will not turn on a dime and certainly there's no sign of strength, but at least it's not getting worse and worse and worse."