This article presents the Trader Edge aggregate neural network model forecast for the March 2015 non-farm payroll data, which is scheduled to be released tomorrow morning at 8:30 AM EST.
Non-Farm Payroll (NFP) Model Forecast - March 2015
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: February and March 2015. The February data was released last month and the non-farm payroll data for March 2015 will be released tomorrow morning at 8:30 AM EST.
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 76,900 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 February 2015 is in the second data row of the table (in purple). The consensus estimate (reported by Briefing.com) for March 2015 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 February 2015 to March 2015.
The aggregate neural network model forecast for March is 220,000, which is up 30,000 jobs from last month's revised forecast of 190,000. The increase in the forecast from February to March reflects a modest strengthening in the employment environment during the month of March. The Briefing.com consensus estimate for March is 250,000, which is down 45,000 jobs from the February report, indicating a significant softening in the employment environment. The actual February data was much higher than the revised February forecast (+1.37 S.E.), indicating a likely outlier. The consensus estimate for February is again above the model forecast (+0.39 S.E.).
If we ignore the large NFP outliers, there had been a gradual and sustained positive trend in the employment data from mid-2012 through January of 2015. The trend is easier to see in the forecast data due to fewer outliers. To test the strength of the trend that began in mid-2012, a few months ago I ran a simple linear regression on the monthly NFP forecast data (dependent variable) against time (independent variable).
The R-squared of the linear regression was 56%, indicating that 56% of the variation in the forecast data was explained by the simple linear trend model. The coefficient for the monthly slope variable was 3.12, which represented an incremental increase of 3,100 jobs per month. The slope coefficient was highly significant with a t-statistic of 6.41 and a P-value of 3.31E-07. The standard error of the model was 27,850 jobs.
The simple linear regression model cannot be used long-term due to the cyclical nature of employment, but it can be useful for quantifying short-term trends in the data. The linear regression model forecast for March 2015 is 271,000 which is much higher than the aggregate model forecast of only 220,000.
The positive trend in the model forecasts has definitely leveled off and possibly started to reverse direction. The recent divergence between the short-term linear regression forecast and the more sophisticated and adaptive aggregate model forecast is troubling and may indicate a weakening in the positive employment growth trend that has been in place since mid-2012.
The difference between the March NFP consensus and March NFP forecast suggests an increased probability of an downside surprise tomorrow, especially given the large outlier in the February NFP data.
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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