Why Aren’t More People Looking for Jobs?

One reason the unemployment rate has come down from 9.3% at the start of 2011 to 7.4% last month is the decline in the Labor Force Participation Rate (LFPR).  The LFPR is the number of people with jobs (employed) or looking for jobs (unemployed) divided by the civilian, noninstitutional population (see here for exact definitions).  At the start of 2011 the LFPR was 64.3% and the latest value is 63.4%.  That may not seem like a big drop, but it represents about 2.4 million people, and if the LFPR had held steady at 64.3% over the last two-and-a-half years, the unemployment rate would currently be 8.7% instead of 7.4%.

If the LFPR is decreasing, that means there are more adults not looking for work.  This could either be a positive or negative sign for the economy.  If the decline is due to discouraged job hunters giving up their search for a job, that would be a negative sign.  If the decline is due to a natural aging of the population because of demographic trends (more older folks retiring), that would be a positive (or at least neutral) sign.

The Bureau of Labor Statistics publishes a slew of data on this issue from its Current Population Survey (also known as the Household Survey).  Let’s take a look at some of this data and see if it can shed any light on why the LFPR is decreasing.

Population by Age Group

Conventional wisdom is that the country’s population is skewing older as the baby boomer generation enters their later years.  The chart below shows the breakdown in the civilian noninstitutional population for each July since 2013.

Population by Age Group

In the last two years, the fraction of the population over the age of 65 increased by 1.2%, and the fraction between 55-64 increased by 0.4%.  In contrast, the percentage between 45-54 decreased by 0.7%, between 35-44 decreased by 0.4%, and between 25-34 by 0.4%.  Given this trend of fewer adults (percentage-wise) in their prime working years and more adults in their later years, we would expect the labor force participation rate to decline over this period, and in fact it does:

LFPR

Labor Force Participation Rate By Age

The chart below shows the LFPR by age group since 2003.  Note that these are not seasonally adjusted; both the 16-19 (dark blue line) and 20-24 (red line) cohorts show strong seasonal patterns as high school and college students look for summer employment.  There is a strong upward trend in the LFPR for 65+ workers (light blue line at the bottom of the chart), from 14% in 2003 to a peak over 19% in 2013.  Given the persistence of this trend in both good (2004-6) and bad (2008-10) economic environments, one could conclude this is not purely a reaction to the economic climate, but rather due to noneconomic factors, such as an increase in health and ability to work for those over 65, or change in cultural expectations about the appropriate age to retire.

LFPR by Age Group

The chart below shows a blow-up of the 65+ cohort from the chart above.  There has been a clear linear trend over the last 10 years for more older workers.  Note the downtick the last two months:  In May the participation rate for those 65+ was 19.2%, and this dropped to 18.8% in June and 18.3% in July.  Two months isn’t nearly enough to declare a new trend, and I would expect the rate to mean-revert back to the trendline as it has the previous times it’s dipped, but it’s something to keep an eye on the rest of this year.

LFPR 65+

If there is evidence of LFPR decline due to discouraged workers, it would have to be in those under the age of 55, since the participation rate has been increasing above age 55.  The chart below shows the three cohorts between 25-54.  Each series has declined between 1.5-2.0% since the great recession.

LFPR 25-54

This decline in LFPR since 2008 for people between 25-54 is similar for men and women, though the decline for men is slightly greater.  In rough terms, the men’s LFPR fell 2% and the women’s LFPR fell 1.5%.  (Therefore, the often-heard argument that the overall decline in LFPR is due mostly to more women choosing to stay home with their children doesn’t hold water.)

This puts a negative slant on the falling unemployment rate; the falling LFPR for people in their prime working years indicates an increasing number of discouraged workers.  The  LFPR falling due to an ageing population, however,  is a natural demographic occurrence, and doesn’t have negative economic connotations. How much of the recent fall in the unemployment rate was caused by each of these two items, and what can we expect going forward?

Unemployment Rate Calculation

From July 2009 to July 2013, the LFPR fell 2.2% from 66.2% to 64.0%.  Isolating the effect of the ageing population, we find that it accounts for just about half the fall in LFPR, or 1.1% (I calculated this by keeping the participation rates by age constant at 2009 levels).  Isolating the effect of the change in participation rates (younger workers participating less), we find that 1.2% of the decline in LFPR is due to people opting out.  Thus about half the decline in LFPR was due to the ageing population, and half was due to younger-aged cohorts participating less.

What does this mean for the future of the unemployment rate?  Suppose the participation rates hadn’t changed over the period.  As mentioned before, this would mean the LFPR would be 1.2% higher than it is today, or about 2.9MM people greater.  Suppose also that all of these people started looking for work tomorrow.  Then both the labor force and the ranks of the unemployed would increase by 2.9MM people, which would increase the unemployment rate by 1.7%.  Obviously this isn’t going to happen, but you can see the headwind for the unemployment rate if people start opting back in.

Countervailing this is the continued ageing of the population.  If the population trends shown in the stacked bar chart above continue, and LFPR by age group holds constant, the overall LFPR would fall by about 0.2% per year just to population shifts, and the unemployment rate would fall about 0.3%.

To recap, the ageing population provides a small tailwind for the unemployment rate, to the tune of 0.3% per year.  If participation rates by age group stay the same, this will be the key demographic driver of the unemployment rate.  However, I would expect participation levels to increase toward levels seen before the great recession which will mean a significant headwind to further reductions in the unemployment rate, as a large group of people reenter the workforce.

Weak Jobs Report

As I thought might happen based on recent economic data, Friday’s jobs report was disappointing.  The change in nonfarm payrolls showed an increase of 162,000 versus a forecast of 185,000, and the prior two months were revised down by a total of 26,000 jobs.  I was expecting an even smaller increase in this month’s jobs as the average of weekly continuing jobless claims increased for the second month in a row.  The chart below shows the relationship between the monthly change in non-farm payrolls and the change in average continuing claims from the prior month since the beginning of 2011(recent points in red).  The change from June to July was the largest increase in continuing claims over this time period.

July Jobs

Another negative in the report was the decrease in average hourly earnings, which fell by 0.1% in July.  On a year-over-year basis, average earnings increased by 1.9%, a low number considering that CPI is just about at this level.  This means that any productivity gains are accruing to corporations rather than workers, which is positive for equities but not so much for consumers.

The Fed’s favorite measure of inflation, the Personal Consumption Expenditures Core Price Index, was up 0.2% for July and up 1.3% year-over-year.  This type of low inflation number will give the Fed confidence that their bond purchases and interest rate policy are not yet showing any inflationary indications, and this will lessen the case for tapering.

It wasn’t all bad news for jobs on Friday, as the unemployment rate came down from 7.6% to 7.4%.  This was due partly to a better gain in the Household Survey of 227,000 jobs, and partly to a decrease in the labor force participation rate from 63.5% to 63.4%.  That is, the Household Survey showed a decrease in the labor force of 37,000 people in July, which caused the unemployment rate to be lower.  Some view this decline in the labor force as people giving up looking for work (a negative outlook), and others view it as a demographic result of baby boomers retiring (a neutral or positive outlook).   The chart below shows the labor force (left scale) increasing by about 90,000/month since the start of 2011, and the participation rate (right scale) decreasing over that same time period.  Due to population growth, the labor force continues to grow even with declining participation.

Labor Force July 2013

Jim Bullard, the Federal Reserve Bank of St. Louis president and FOMC member, addressed this issue on Friday in the context of tapering asset purchases.  He said that a key issue for the FOMC is whether they should focus attention primarily on nonfarm payroll changes and the unemployment rate, or should they consider a wider range of labor market indicators.  Other measures, he noted, such as the labor force participation rate, have not seen much improvement since the Fed adopted its latest asset purchase program last September (it’s dropped from 63.6% to 63.4%).  If they do put more emphasis on these other measures, tapering may be pushed out further.

Taking all this together, the market viewed the economic data negatively for the economy, and the yield on the 10-year Treasury fell from 2.74% before the announcement to close the day at 2.60%.  The 30-year Treasury also fell, from 3.77% to 3.68%.

For those focused on the September Treasury call options expiring on August 23, this is going to be a very slow news week in terms of economic data releases.  I would look to exit positions at some point this week to take advantage of the recent gain and while there’s still some time value on the options.

FOMC Meeting Statement

For those that parse every word of the Federal Open Market Committee’s statement, there was little change from the last release on June 19 to today’s release .   Last month the economy was expanding at a “moderate” pace and now it is at a “modest” pace.  Looking ahead, economic growth will “pick up from its recent pace” instead of “proceed[ing] at a moderate pace.”  They also added that “inflation persistently below its 2 percent objective could pose risks to economic performance,” but it will “move back toward its objective over the medium term.”  Taken all together, this is a slightly more negative slant on the economy than last month, and therefore the Fed may be slightly less likely to taper their $85MM in bond purchases starting in September.  In fact, the bond markets reacted with a “modest” rally, as yields on 10-year treasuries fell 8bps, from 2.66% just before the announcement to 2.58% at the end of the day.

What I think is more telling is the recent economic data.  Although 2nd quarter GDP (released this morning) was 1.7%, a good deal higher than the forecast of 1.0%, it is still very low, and first quarter’s GDP was revised down from 1.8% to 1.1%.  Durable goods orders (released last Thursday) excluding transportation were flat, and nondefense capital goods excluding aircraft that were shipped in June were down almost 1% (although orders were more positive).  Continuing weekly unemployment claims remain higher than the average for both May and June at 2,997,000.

I believe this sets us up for disappointing news when the unemployment rate and change in nonfarm payrolls are released Friday morning.  Expectations are for a drop in the unemployment rate from 7.6% to 7.5% and 185,000 new jobs, but I think it is more likely we underperform these estimates than outperform.  Last week, I liked the September call options on 10-year treasuries with strikes 138-140 that expire on August 23.  Although they didn’t have a good week (yields rose), I think there is a greater chance of a significant drop in yields than is being priced into these options, so they still look like good values.

Hold on (you might be saying), isn’t this blog about yields going higher?  Yes it is, but I don’t want to ignore data that runs contrary to my thesis.  At this point it seems that more data is pointing toward lower yields than higher.  However, I believe this is a short term trend in a much larger and longer movement higher in yields.

Speaking of data, there is market-moving economic news tomorrow ahead of Friday’s jobs release.  In addition to the usual weekly unemployment claims (initial and continuing) at 8:30, there’s the ISM Manufacturing Index for July at 10:00.  Stay tuned.

Yields Headed Lower?

The yield on 10-year U.S. Treasuries hit their closing high on July 5 at 2.74% based on a good monthly jobs report and lots of tapering talk.  Since then, Bernanke and others have dialed back the tapering rhetoric, and yields dropped 26bps to close at 2.48% on Friday.  I think they will drop further over the next few weeks.

Take a look at the weekly continuing unemployment claims series:

Continuing Claims 2013-07-21

In the last two weeks, the number of continuing claims has jumped by 161,000, the most since the recovery began in 2009.  The number of initial claims has been pretty decent recently, in the 330-360K range.  So why have the continuing claims jumped so much?  Either companies have started to pare back layoffs but aren’t yet hiring new employees, or more people are looking for jobs (higher labor force participation rate), and the increased competition is making it harder for those unemployed to find a new job.  In either case, this should mean a higher than expected unemployment rate when the data is released on August 2.  I’ll say more about that in the next week.

Although in the long term, I still believe that yields are headed higher, to take advantage of this (potential) short-term downward movement in yields, , I’ve been looking at September options on the 10-year U.S. Treasury futures (September contracts).  These expire on August 23, after the unemployment report.  The implied volatilities on the call options with strikes 138, 139, and 140 are all around 9% – pretty reasonable.

Not Exactly Going Out on a Limb

The weekly unemployment claims data comes out tomorrow instead of the usual Thursday due to the July 4th holiday.  According to Bloomberg, economists are expecting 345K initial jobless claims.  Last week we had 346K initial claims, the average of the last 5 weeks is 348K, and the average of the last 10 weeks is 344K.  The Bloomberg number of 345K is an average estimate of 50 predictions ranging from a low of 334K to a high of 360K – a pretty narrow range around the mean and not particularly illuminating. The forecast isn’t giving us any information that we couldn’t have gleaned just from looking at the past few months; there’s a strong consensus for “more of the same” with respect to initial claims.

Yields will move tomorrow if the initial claims are significantly different than the forecast, but as readers of this blog know, I focus more on the continuing claims, because they better predict changes in monthly nonfarm payrolls (the nonfarm payrolls number for June, as well as the unemployment rate, will be coming out on Friday). Continuing claims will also be released tomorrow, and the Bloomberg forecast is for 2,958K.  If that’s correct, the average continuing claims for the first three weeks of June will be 2,963K.  Keep in mind that there is an additional delay of one week for continuing claims, so this will not be the final number for June, but it should provide a pretty good idea of what June’s average will be.

The average of continuing claims for May was 2,972K, so if the average for June is 2,963K, that’s only a drop of 9K.  The chart below shows a plot of the change in nonfarm payrolls (vertical axis) versus the change in average monthly continuing claims (horizontal axis) from the start of 2011.  Each point on the chart represents a particular month, and the points in red represent the last 12 months.  I’ve also highlighted a range where average continuing claims dropped about 9K (the range goes from a drop of 0K to 20K).

Jobs vs Continuing Jun 2013-2

Of the nine months in the highlighted range, four had changes in nonfarm payrolls of less than 165K, one was right at 165K, and four were higher.  Why is 165K important?  That’s the Bloomberg forecast number for Friday’s nonfarm payroll report. So if the average June continuing claims drops by roughly 9K, as predicted, there’s about a 50/50 chance of the nonfarm payroll number coming in below expectations. Obviously, this is a rough representation of reality, but we can still conclude that it’s a coin flip as to whether changes in nonfarm payrolls will be above or below expectations.

What does this all mean? Well, if the continuing claims number comes in tomorrow at 2,958K as predicted, the change from May to June in continuing claims would be small, meaning a 50/50 chance of seeing a disappointing payroll number on Friday.  Given the recent run-up in yields (the 10-year U.S. Treasury has gone from 1.63% on May 2 to 2.47% today), I believe there is more likely to be a large drop in rates on disappointing jobs news than a large rise in rates if the jobs news is good. So unless the continuing claims number tomorrow is much better than expected, say 2,940K or lower, I’ll be looking to exit my treasury short position to avoid the reasonable chance of a large drop in yields from poor news on Friday.

Additional Data

After the market closed today, the monthly car sales numbers were released, and the data was very positive.  The total vehicle sales (annualized) was 15.9MM, the highest it’s been since the financial crisis, and almost back to the 2003-2006 level, when it fluctuated between 16-18MM.  Treasury futures did not move much on the news, which is somewhat surprising. Perhaps this indicates that positive news isn’t having as big effect on yields as it has had over the past two months.

FOMC Announcement

The Federal Reserve Open Market Committee concluded their two day meeting earlier today and released their usual statement summarizing their policy and analysis. Following the FOMC statement – which was more optimistic about the economy than in prior months – Ben Bernanke held a press conference in which he indicated asset purchases (QE3) will likely be reduced later this year and terminated next year.

The treasury markets responded with a sell-off, and the yield on 10-year treasuries climbed from 2.19% to 2.35% and the 30-year yield rose from 3.34% to 3.41%.

Analysts dissect these statements and press conferences in great detail, and a lot has already been written about today’s news on the financial sites, so I’ll focus here on two items I haven’t seen elsewhere.

During his press conference, Bernanke said, “If interest rates go up for the right reasons, that is, both optimism about the economy and an accurate assessment of monetary policy,  that’s a good thing, not a bad thing.”

This is a very bullish statement for yields.  Before this, we might have expected the Fed to look negatively on a rise in yields no matter what the reason, as increased treasury yields will lead to higher borrowing costs for individuals and businesses, which could slow down economic growth.  Bernanke could have said that he would be willing to tolerate a limited rise in yields, but not an excessive increase. With this statement, Bernanke is indicating that if the economy seems to be doing well, the Fed would be happy to let yields rise and not take any additional easing actions to bring them back down.

Second, there was not a single mention of Europe in the press conference Q&A.  This is not that surprising because the economic problems in Europe are mostly off the radar screen here in the U.S.  However, I believe that risk-averse investors avoiding European sovereign debt have contributed to the current very low rate environment in the U.S.  Recall that in the first half of 2011, rates for 10-year Treasuries were between 3-3.5%, and then plunged precipitously in August to 2% as concern about Greece, Italy, and Spain spurred investors to buy treasuries for safety.  Similarly, during the Cyprus banking crisis earlier this year, yields fell from 2.0% to 1.7%.

As the beginning of the end of QE3 approaches, and assuming there is no new crisis in Europe, yields will continue to rise. Since the Fed has indicated it won’t take action to bring them back down, I believe treasury yields will rise back to the 3-3.5% level. Of course, it won’t always be smooth sailing. For example, there’s still the debt ceiling, which will come back into play towards the end of the year.  More on that another time.

Good News for the Unemployment Rate

The Federal Reserve Bank of Chicago just came out with a research letter on the trend in employment growth.  Based on the growth in population, the declining labor force participation rate, and the natural rate of unemployment, the authors forecast that 80,000 new jobs per month are required to hold the unemployment rate steady.  Jobs growth of greater than 80,000 per month would mean a reduction in the unemployment rate.

In my post from last month, I forecast that if we continued to see 180,000 new jobs per month (the average since 2010), the unemployment rate would be 7.0% by the end of this year.  Here’s a reprint of the chart:

Unemployment Rate Forecast

Let’s see how the Chicago Fed’s forecast ties in with my analysis. If we get the 180K new jobs (per month) I used in my calculations, that’s 100K jobs above the 80K new jobs the Chicago Fed said would hold employment steady.  Dividing those 100K new jobs by the civilian labor force of approximately 155MM produces a drop in the unemployment rate of 0.064% per month.  If we get this same 0.064% drop every month, we’ll see a drop of 8*0.064% = 0.52% in the unemployment rate by year-end.  The current unemployment rate is 7.51%, so that would put the unemployment rate at the end of the year right around my original forecast of 7.0% – good to get an independent confirmation.  A 50 bp drop in unemployment this year would be a good result for the economy, and I believe the Fed would start tapering QE3 asset purchases before year’s end if this scenario plays out.

Monthly Jobs Report

The monthly jobs report comes out tomorrow, and since this is the primary item the Fed is focusing on to make policy decisions it is what everyone else is focusing on as well.  The Bloomberg survey shows experts think the number of new jobs (change in nonfarm payrolls) will be 165K.  I have shown a relationship between the average of the weekly continuing unemployment claims and the change in nonfarm payrolls.  Here’s the latest chart, in which each month from the beginning of 2011 through April is represented by a point (last 12 months in red):

Jobs vs Continuing Apr 2013

So far, the May data shows that the change in average continuing claims is down 70K from last month.  There aren’t a lot of data points, but in the past this has indicated a change in non-farm payrolls of 200K+.  I think it’s likely, therefore, that we beat the survey’s expected number of 165K.  If we do, expect yields to rise.

According to the Bloomberg survey, the unemployment rate is expected to hold steady at 7.5%.  Given that 80,000 jobs will keep the unemployment rate constant, and I think it is very likely that we will beat this number, it’s more likely that the unemployment rate will move down to 7.4% or lower tomorrow than to rise to 7.6% or higher.  Again, this makes it more likely that yields will rise after tomorrow morning’s news.