Capacity Utilization and Unemployment

As an addition to the previous post about how GDP is lagging potential GDP, it's worth pointing out that unemployment is the major driver of the gap.  Below is a chart which plots the employment rate (inverse of the unemployment rate) against the potential GDP gap.  Also included is capacity utilization data, which is compiled by the Fed and is also still below its peak from the last cycle.  Capacity utilization has been trending lower for decades.

How Fast Should We Expect Unemployment to Decline?

To go along with the previous post forecasting when a 6.5% unemployment rate could occur, below is some analysis on how fast unemployment typically drops when we are in a period of falling unemployment.  Since 1949 there have been 10 periods of falling unemployment.  On average the unemployment rate falls by about 7 bps per month when it is declining.

Although the "scariest jobs chart ever" which has made the rounds on the internet implies that unemployment is falling at a much slower pace than it has in past cycles, in reality, we're basically in line with the average rate of decline (the unemployment rate just spiked from a lower base than it had in the past.)

When Will Unemployment Hit 6.5%?

As part of today's statement, the Fed acknowledged that it would be maintaining the current QE rate until unemployment hits 6.5% or inflation gets out of hand (paraphrase).  Below is an estimate of when unemployment could hit that level based on an extrapolation of the current pace of decline.  Since peaking in late 2009 at 10%, the unemployment rate has fallen on average at about 6 basis points per month (.06%).  If it continues at this pace, the unemployment rate would hit 6.5% in mid 2014.

[Note that the decline has not materially picked up much pace in 2012.  In 2012 the rate declined by an average of 7bps per month.  At this pace 6.5% would occur just a few months earlier in 2014.]

Financial Sector Employment

Bank of America announced that it would cut 16,000 more jobs today in order to continue to cut costs amid a weak environment for financial services businesses.  The announcement adds to the continued attrition of financial sector jobs: since 2006, the financial sector has lost a total of 600k jobs.

Below is a long term chart of US employment in the financial sector.  As a percentage of total workforce, financial services actually peaked in 1986 at 6.27%.

Nonfarm Payrolls Relationship to Jobless Claims

On Friday, we'll get the monthly employment report, which is expected to show an increase of 130k non-farm payrolls.  Even though the broad employment report comes out once per month, each Thursday we get a glimpse of what the employment situation looks like from initial jobless claims.  Initial claims reports can often move the market, but how good is the initial claims data at predicting payrolls?

Below is a regression of the 4-week trailing average of initial claims against the monthly payrolls data.  The r-squared of the simple linear regression is .54--not a perfect correlation, but relatively meaningful.

Recently, the 4-week average of initial claims has risen somewhat, back to 370k.  From the regression 370k initial claims would imply somewhere around a 55k increase in non-farm payrolls.  This would be well short of estimates.

What Percentage of the US Population Works?

Below is a chart of the employment/population ratio for the US.  It measures the percent of the population in the US that is working.  Even though the unemployment rate is 8.2%, that only measures those looking for work who can't find jobs.  The number below takes into account the whole population.  At 58% of the population employed, the number is the lowest it's been since 1984.  The employment ratio for men is near an all time low set in 2010.

Still, compared to some other developed countries the percentage of the US population that is working is relatively high.  In Italy, less than half the population is employed.