Tuesday, January 14, 2014

December 2013 Employment Report

I was surprised to see interest rates fall back on the release of the December Employment Report.  The markets seem to be discounting the 6.7% unemployment rate because of the low payroll jobs number and the drop in labor force participation.  All of these numbers have a lot of noise.  I would say that in the current environment, the unemployment rate is as relevant as the other two numbers.  In any case, I would have expected it to be kind of a wash.  But other analysts seem to share a consensus view that it was a poor report.

Here is a look at the trend in Labor Force Participation (LFP) and the Employment to Population Ratio (EPR).  I have also added the long term Labor Force Trend and the Employment Ratio that would produce a 6.0% unemployment rate (UER):

Even though the drop in the UER was due to a drop in the LFP rate, the EPR held strong.  The current trends in LFP and EPR would put the UER at 6.0% by early 2015, even if we consider the December report an aberration.

The labor market still appears weak even at that point in 2015, with an LFP below trend, but this is not unusual.  Here are graphs of the same measures during the 1990 and 2000 downturns.

The UER hit 6% in mid-1994, and LFP didn't recover to trend until early 1997.  The 2000 downturn was much more mild, with the UER topping out at about 6%.  But, even there, the UER started dropping below 6% by the end of 2003, while LFP stayed at the trend until mid-2005.

If we hit 6.0% UER this year, an LFP finally pulling back to trend in 2017, at a rate similar to today's rate of about 63% would be consistent with the current demographic trend and with the experience of previous downturns.

I think there is a case to be made for a more optimistic outlook.  I have posted previously on the three factors that I believe have had the largest impact on these labor market measures in the past 5 years - demographics (seen in the LFP trendlines here), minimum wage (which I believe reduced LFP by more than 1% at its peak, and still is responsible for most of the movement of LFP below trend), and Emergency Unemployment Insurance (EUI).

I have estimated that EUI added more than 1% to the UER and subtracted added about 1/4% from to LFP.  But, we now have two instances (North Carolina in June, and the U.S. currently) where LFP has dropped precipitously in the months leading up to the termination of the policy.  So, possibly EUI had more of an effect on LFP than I had expected.  I don't have a comprehensive narrative understanding of how EUI and LFP are interacting, but at a basic level, the tendency of EUI to inflate LFP should be obvious.

I would suggest that, to the extent that some of this movement is related to EUI, we should consider the new LFP level to be the natural level, and the LFP level from the past few years to be elevated.*  I realize that with all the LFP doomsaying, this seems like an odd thing to say, but I've discussed the LFP issue many times before.  The doomsaying is wrong.

The other prediction that would follow from the termination of EUI is an uptick in the EPR.  (North Carolina also saw a decrease in regular unemployment claims after June, but that could be related to other cuts they made in the program.)

In addition to expecting these changes, I also would expect to see LFP flatten out and start to slowly close in on the descending LFP trend line.  Part of this is simply strength that should eventually come from an improving labor market.  But, I think the distance we are getting from the minimum wage increases will help this rebound.  In 2007, 1.1% of the labor force worked at or below minimum wage.  After the 3 hikes from 2007 to 2009, that topped out at nearly 3%.  It is back around 2% now.  As this slowly falls back toward 1%, I would expect a rebound of more than 1/2% in LFP, relative to trend.  I doubt that we'll see LFP ever get much above 63%, though.

Taking all of these factors into account, and adjusting our forward expectations, an UER under 6.0% by the end of summer 2014 and a LFP back above trend in 2017 are feasible.

Of course, a new round of minimum wage hikes or a hawkish monetary freak out by the Fed would spoil these expectations.  Until either of these things happen, I continue to believe that forward interest rates in the 2 to 3 year range are about 0.5% below the expected eventual expiration levels, and they will generally bounce around a stable range as time passes.

* Addendum: Except for the long duration issue, the labor market is at healthy levels.  Continuing and Initial claims, and job openings, are all at levels associated with an UER of 5%.  While hiring is still at a level that would have previously been associated with UER over 6%, quits have returned to the level where they were when the UER previously topped out at 6%.  If, after the termination of EUI, we have an UER under 6% within a few months, this would be more in line with the other indicators.  I think we could expect to see a related increase in hiring and quits associated with the resulting reduction in labor market frictions as well.  I suspect that if that comes to pass, there will still be a bearish mood about the labor market, because while LFP might still be 1% below trend, there will still be a large contingent claiming that it is 3% too low.  I don't know what it will take to quiet that contingent, because no employment boom is ever going to get LFP back to 66%.

1 comment:

  1. Judging from these statistics we may be in one bumpy year again. I just hope the percentage of people quitting their job would go down just a little. Anyway, thanks for sharing your insights, Kevin! In order for companies to keep their quality of work, they turn to professional establishments to aid them in screening individuals out of many candidates for a chance to help improve their company.

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