This article presents the Trader Edge aggregate neural network model forecast for the August 2014 non-farm payroll data, which is scheduled to be released tomorrow morning at 8:30 AM EDT.

Non-Farm Payroll (NFP) Model Forecast - August 2014

The Trader Edge aggregate NFP model represents the average of three neural network forecasting models, each of which employs a different neural network architecture.  Unlike expert systems, neural networks use algorithms to identify and quantify complex relationships between variables based on historical data.  All three models derive their forecasts from seven explanatory variables and the changes in those variables over time.

The table in Figure 1 below includes the monthly non-farm payroll data for two months: July and August 2014.  The July data was released last month and the non-farm payroll data for August 2014 will be released tomorrow morning at 8:30 AM EDT.

The model forecasts are in the third data row of the table (in blue).  Note that past and current forecasts reflect the latest values of the independent variables, which means that forecasts will change when revisions are made to the historical economic data.

The monthly standard error of the model is approximately 79,600 jobs.  The first and last data rows of the table report the forecast plus 0.5 standard errors (in green) and the forecast minus 0.5 standard errors (in red), respectively.  All values are rounded to the nearest thousand.  If the model errors were normally distributed, roughly 31% of the observations would fall below -0.5 standard errors and another 31% of the observations would exceed +0.5 standard errors.

The actual non-farm payroll release for July 2014 is in the second data row of the table (in purple).  The consensus estimate (reported by Briefing.com) for August 2014 is also in the second data row of the table (in purple).  The reported and consensus NFP values also include the deviation from the forecast NFP (as a multiple of the standard error of the estimate).  Finally, the last column of the table includes the estimated changes from July to August 2014.

Figure 1: Non-Farm Payroll Table August 2014

Model Commentary

The aggregate neural network model forecast for August is 213,000, which is down 29,000 jobs from last month's revised forecast of 242,000.  The decrease in the forecast from July to August reflects a continued weakening in the employment environment over the past two months. The Briefing.com consensus estimate for August is 223,000, which is up 14,000 jobs from the July report, indicating a modest strengthening in the employment environment.  The actual July data was notably below revised June forecast (-0.41 S.E.) and the consensus estimate for August is marginally higher than the model forecast (+0.13 S.E.).

If we ignore the extraordinary outlier in the December data (-1.92 S.E), there had been a gradual and sustained positive trend in the employment data from late 2012 until mid-2014.  However, that trend has begun to reverse in the last two months.  Not surprisingly, the variation in the actual NFP reports is much wider than the variation in the NFP forecasts.  Unfortunately, the Government reports are notoriously noisy, so the trend is more apparent in the forecast data, which are based on several different economic variables that collectively give a much more accurate and reliable employment reading than the Government data.

The minimal difference between the August NFP consensus and August NFP forecast provides little if any insight into the direction of a potential surprise tomorrow.

Figure 2: Non-Farm Payroll Graph August 2014

Summary

Basic forecasting tools can help you identify unusual consensus economic estimates, which often lead to substantial surprises and market movements.  Identifying such environments in advance may help you protect your portfolio from these corrections and help you determine the optimal entry and exit points for your strategies.

In the case of the NFP data, the monthly report data is highly variable and prone to substantial revisions.  As a result, having an independent and unbiased indicator of the health of the U.S. job market is especially important.

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