Employment Data Shows Recession at Least One Year Away

Initial Jobless Claims as a Leading Indicator

When it comes to Initial Jobless Claims, labor is a leading - not a lagging - indicator.

All business investment decisions, from capital to labor, are responses to business expectations of economic growth. So while hiring and firing certainly lag business expectations, they move in step with the economy's ebb and flow. Jobless Claims coincide with the GDP, as seen in the following chart:

Four factors make Initial Jobless Claims a leading indicator:

  1. High quality data. Unlike other data that is sampled and modeled, Initial Jobless Claims are comprehensive and more accurately depict the state of the labor market.
  2. Data gets released before any other macroeconomic data point. Initial claims are a real-time snapshot. Conversely, GDP data gets released a month after the period ended, and even then it covers economic activity as much as four months old. The decisions to hire or fire may coincide with business economic decisions, but the data gets reported a lot sooner.
  3. Shifts in hiring momentum lead economic inflection points. Payroll is the first place a business will turn when it needs to change momentum.
  4. Initial Jobless Claims focus on the most economically sensitive workers. The ebb and flow of claims is driven by demand for part-time and temporary workers. These are the workers who are first to be hired and first to be fired in any slight shift of economic conditions.

Leveraging Jobless Claims: Watch Out For 280K Claims

Recessions start roughly 12 months after claims fall to 280K+/-. More important than the actual number is the following pattern:

  • A sustained bottom (~10 weeks) at 280K+/-
  • A sustained rise (~10 weeks) in claims of +20K

Far from signaling a tight labor market, the 280K level signals the start of economic weakening. Right now claims are hovering around 290K. We need to pay attention.

The 95% Factor

Instead of an absolute number (like 280K Claims), focus on a relative number: the number of claims today versus the number of claims last year. An expanding economy will have fewer Jobless Claims today compared to the same period a year before: Year-over-year (Y/Y) claims are less than 100%.

Practically speaking, the rate to watch is 95%. At 95%, the Y/Y difference is under 15,000 claims. That's noise in an economy with 125M on the payroll. In December 2007 - when the economy officially entered a recession - the Y/Y rate was 104% as there was 20K more claims than in the prior year. In March 2001, it was 140% of the prior year. But start the clock 12 months before those recessions officially began and the Y/Y rates were 97% and 96%, respectively.

The key point: once claims are within spitting distance of the prior year, a recession is 12 months away. We are currently at 91% (9% fewer claims in March 2015 compared to March 2014). While the current 290K level of claims indicates that we are approaching a bottom, the 91% rate says that we remain in healthy, economic expansion territory.

Breadth and Depth: Confirm With a State-Level Drill Down

Events in California and New York can skew the claims picture. Also, regional developments like hurricanes can distort the picture. But when the majority of states have Y/Y claims rates above 95%, trouble is brewing.

For example, look at the previous business cycle. Concerns about the economy began to surface in 2006. Second quarter 2006 GDP slipped to 1.2% and then to 0.4% in the third quarter. That 95% Factor was also signaling problems. In the second quarter of 2006, half the states still had Y/Y Jobless Claims below 95%. By the third quarter, barely 15 states were below 95% (barely 1/3 the total). The recession started nine months later.

Jobless Claims Today: Like It's 2006

There are two reasons to think the economy is like 2006 and heading for slowdown:

  1. Claims are again approaching 280K
  2. The Y/Y rate will hit 95% in July. Beginning in July 2014 (last year), claims began their sustained drop to 300K

Taking all this into account, the Jobless Claims data signals the claims bottoming in the second half of this year.

A state-level drill-down favors continued economic growth, a la 2006. There's been a lot of distortion in the last few months. 2014 looks especially strong because it's being compared to the weak second half of 2013 (a sequester followed by heavy snowstorms). By the same token, 2015 is looking especially weak because of recent unseasonal storms. But even with that distortion, the first quarter of 2015 shows broad strength as roughly half of the states fell below the 95% Y/Y rate.

Basically, the state-level data will be a better gauge starting in the second quarter.

Interview with Andrew Zatlin on Vice Index and U.S. Economy

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