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How to prepare for this week's critical number

Sunday, 2 Feb 2014 | 5:00 PM ET
How to trade the jobs report
Friday, 31 Jan 2014 | 1:16 PM ET
How will stocks react to the January jobs report? Jim Iuorio and Brian Stutland discuss with Bertha Coombs.

The January payrolls report will be released on Friday, and investors will be watching it closely as they attempt to gauge the strength of the economy and predict the Federal Reserve's next move.

And while the employment report always tends to be the single most important economic indicator released in a given month, Friday's unemployment report is expected to take on even more gravity than usual.

The December report showed that only 74,000 jobs were created by the nonfarm payrolls metric—a surprisingly low number that most were quick to dismiss as a statistical anomaly, especially because the report also showed that the unemployment rate fell from 7.0 percent to 6.7 percent. Whether that nonfarm number will be revised upward is an open question that will be resolved on Friday. On the other hand, a weak job creation number could show that December's report was more than a blip.

"I will always remember the sound I heard on that trading floor when that last number printed at 74,000. It was just an 'ugh!' over the whole trading floor, and it was awful," said Jim Iuorio of TJM Institutional Services. "So I do think people will start worrying about the employment numbers."

For January, economists are expecting to see 170,000 jobs created, though the unemployment rate is projected to remain flat at 6.7 percent.

(Read more: Chart of the Day: The real unemployment rate?)

Where those number do come in could also have great ramifications for the Federal Reserve. While the Fed seems determined to reduce quantitative easing by $10 billion in each meeting until the now-$65-billion program is tapered away completely, the state of federal funds rate could be a more open question.

In its January statement, the Fed copy-and-pasted confusing guidance regarding what the unemployment rate will mean for the highly influential funds rate. The statement says that "The Committee also reaffirmed its expectation that the current exceptionally low target range for the federal funds rate of 0 to ¼ percent will be appropriate at least as long as the unemployment rate remains above 6½ percent, inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee's 2 percent longer-run goal, and longer-term inflation expectations continue to be well anchored."

However, a mere two sentences later, the Federal Open Market Committee writes: "The Committee continues to anticipate, based on its assessment of these factors, that it likely will be appropriate to maintain the current target range for the federal funds rate well past the time that the unemployment rate declines below 6½ percent, especially if projected inflation continues to run below the Committee's 2 percent longer-run goal."

Traders work on the floor of the New York Stock Exchange.
Getty Images
Traders work on the floor of the New York Stock Exchange.

As Deutsche Bank, chief U.S. economist Joseph LaVorgna wrote in a recent note that these two passages represent two slightly different outlooks, making for "very confusing" forward guidance. While the first implies that the Fed will consider raising the federal funds rate once the unemployment rate falls below 6.5, the second suggests that such a move is not actually on the table.

(Read more: Here's what changed in new Fed statement)

If the unemployment rate falls below 6.5 percent in Friday's report, then the question of what the Fed actually means will no longer be an academic one.

"The next jobs report will be very important, because we're just 0.2 percent away from 6.5 percent," said Kathy Lien, managing director of FX strategy at BK Asset Management.

"The Fed is in a period of transition, both in leadership and in policy strategies," George Goncalves, the head of U.S. rates strategy at Nomura, wrote to CNBC.com. "This is leading to a period of doubting what the Fed means about its unemployment threshold bogeys, and is also making investors wonder what they will do if we get to their targets for the wrong reasons (i.e., a drop in the labor force). Until we get clarity on what Yellen thinks of this, the market will remain confused with every job print, and with every drop closer to 6.5 percent."

While the first FOMC meeting chaired by Janet Yellen will not release its statement until March 19, investors could get a sneak peak of her views on Feb. 11, when she testifies before Congress.

(Read more: Yellen to be sworn in as first woman Fed chair next week)

In the meantime, several traders say they will be playing for the recent equity weakness to continue. After all, either a weak payrolls number or a big reduction in the unemployment rate has the potential to substantially hurt, or at least further confuse, the stock market.

"Prior to Friday's release, the stock market should trade heavy," Iuorio predicted. "My intention is to sell strength in the early part of the week."


—By CNBC's Alex Rosenberg. Follow him on Twitter: @CNBCAlex.

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