UBS: Outside chances

Last Friday's US payroll figures have sent the likelihood of a June rate hike by the Fed pretty well back to zero. But as ever, we can't hope to understand the implications of one piece of data by looking at it in isolation.

09.06.2016 | 09:23 Uhr

So just when the Fed had finally convinced markets that rate hikes were possible this summer, the labor market data had to go and ruin everything. The 38,000 (38k) new jobs as reported by the US Department of Labor this past Friday was clearly well below expectations, and can only be partly explained away by the strike at Verizon (which when added back would almost double the number). Everyone is dissecting the number, and looking at the details to try to understand it. But sometimes it is worth stepping back and asking: On Thursday what probability would you have assigned to the likelihood of Friday's payroll number being below 50k?

This does not require any real expertise. The simplest way to do it would be to ask what the probability would be of any random month you select giving you a number below 50k. It turns out the answer is about one in three over the last two decades. This naive approach was dubbed the 'outside view' by psychologists Daniel Kahneman and Amos Tversky, because it does not rely on any information about the specific circumstance of today’s economy.

So for example, the outside view on whether it is likely to rain at least 1mm on any given day in London is 35% over the last two decades. Well that's all very well, but surely you know it is June. OK, we can narrow down the outside view a bit to just look at days in June over the last two decades. Sure enough the probability of rain drops (but just to 30% - England has a well-deserved reputation for rain). But that does not take into account any unique information about tomorrow. 

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