“Following the loss of about 8-3/4 million jobs from 2008 through 2009, private-sector employment expanded by a little more than 1 million in 2010. However, this gain was barely sufficient to accommodate the inflow of recent graduates and other new entrants to the labor force and, therefore, not enough to significantly erode the wide margin of slack that remains in our labor market. Notable declines in the unemployment rate in December and January, together with improvement in indicators of job openings and firms' hiring plans, do provide some grounds for optimism on the employment front. Even so, with output growth likely to be moderate for a while and with employers reportedly still reluctant to add to their payrolls, it will be several years before the unemployment rate has returned to a more normal level. Until we see a sustained period of stronger job creation, we cannot consider the recovery to be truly established.” –Ben Bernanke
Fed Chairman Bernanke used his Feb. 9 congressional testimony to reiterate the Fed’s view about the sustainability of the economic recovery. Bernanke’s key point is that we need to see the jobs before we change the policy. Will we?
NY Fed president Bill Dudley embellished this concern in his Feb. 14 briefing. Remember Dudley is vice-chair of the FOMC and, as NY Fed president, the only regional bank president with permanent voting status. He was clear in his message.
“On the labor front, the most recent employment report for January 2011 is quite difficult to interpret. Only 36,000 nonfarm payroll jobs were added, well below expectations. Yet, we get a very different perspective from the unemployment rate, which fell by 0.4 percentage points for the second month in a row and now stands at 9.0 percent. Job growth was undoubtedly held down by the severe winter storms that affected many major cities, including our own. The decline in the jobless rate was not an unmitigated positive, as a significant part of this decline was due to fewer people looking for work.”
We agree with Dudley’s perception. In our view, it is way too soon to celebrate job recovery. The unemployment rate has dropped to 9% from a 10.1% high in October, 2009. Normally, that would be cause for celebration. However, that may not be the casein this cycle.
Let’s talk about the “fewer people looking for work.”
The drop of over a point in the unemployment rate occurred, in part, because the labor force participation rate is falling, as it has been for years. The number of folks looking for work keeps declining. It appears that the number of unemployed who have given up can be measured in the millions. The latest estimate of the participation rate is 64.2%, the lowest in a quarter century. For contrast, the labor force participation rate peaked at about 67% nearly 12 years ago.
The implications for labor income and for Fed policy are profound. The Fed has made job recovery one of its key objectives. That said, the Fed forecasts the unemployment rate and not total employment. Their target is a 7% unemployment rate, to be reached by 2013.
Nell Soss and Henry Mo (Credit Suisse) took the Fed’s target and adjusted it for changes in the participation rate. The results are dramatic. Remember, the lower the participation rate, the more it seems that the unemployment rate is declining. Dropouts are not counted as looking for jobs and the official unemployment rate counts only those who are looking for work and have not found it.
Soss and Mo projected economic outcomes using the current participation rate of 64.2% and another scenario using an improved 65.2%. The shift of 1% in the participation rate means 2.4 million jobs at the end of 2013. In other words, the Fed could see their estimated 7% targeted unemployment rate reached in a very tepid recovery if the participation rate remains low. Alternatively, the Fed could point to a successful policy outcome if the participation rate rises. The difference means a lot.
The Fed minutes released today describe the FOMC’s latest forecast as follows:
”Although participants generally expected further declines in the unemployment rate over the subsequent two years—to a central tendency of 6.8 to 7.2 percent at the end of 2013—they anticipated that, at the end of that period, unemployment would remain noticeably higher than their estimates of the longer-run rate. Many participants thought that, with appropriate monetary policy and in the absence of further shocks, the unemployment rate would continue to converge gradually toward its longer-run rate within five to six years, but a number of participants indicated that the convergence process would likely be more extended.”
So what happens if we have fewer people looking for work?
A higher participation rate generates more income for workers. It yields more tax revenues to the federal as well as state and local governments. It stimulates more housing and adds to purchasing power of consumers.
A lower participation rate means the job recovery engines of the US economy remain rusted. It means slow growth in consumer income. It means weaker housing and worsening budgets at all levels of government.
So far, in this recovery, we see the latter. That means inflation pressures from labor are muted. This has big implications for markets that are discounting heavy future inflation pressures. We may not see the inflation everyone fears.
Neil Soss ends his essay with this note: “The Fed should count jobs, not unemployment.” We agree. Furthermore, the shrinkage of the state and local government sector means that the US needs nearly 200,000 net new jobs a month to keep the true unemployment rate constant. More are needed to lower it and that only works well when more people are looking for work and not fewer.
We are not sanguine about the jobs outlook. We expect a low labor force participation rate; perhaps, it will keep falling. That will encourage the Fed to keep the policy interest rates near zero for the rest of this year and well into next year.
David R. Kotok, Chairman and Chief Investment Officer
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