US Labour Market Report Points To Growing Downside Risks

Summary

• The latest US labour market report shows some modest gains but most of the underlying detail was uniformly negative.
• Payroll employment was up by 661,000 workers but was short of expectations because of government worker layoffs. If state and local governments don’t receive federal aid they may be soon forced to layoff an additional 3 to 5 million people.
• The unemployment rate fell 0.5pp to 7.9% but only because 695,000 people were dropped from the labour force and are no longer counted as unemployed.
• Our measure of true unemployment flat lined at 10.5%, and structural – or non-temporary – unemployment jumped from 6.9% to 7.9%.
• Absent a comprehensive stimulus bill soon, the true unemployment rate could soon rise to 13%.
• We think a stimulus legislation is coming, but how big, when, and in what form remains up in the air. Democrats and Republicans remain far apart in their priorities, and the spike in Covid cases in Washington only heightens the uncertainty.

Market Implications

• Short-term; Neutral; US equity – Equity markets so far have shaken off most bad news on expectations that a comprehensive stimulus package will come soon. There probably is little upside from current levels if a package is passed as it will mostly maintain the economy on life support until the coronavirus crisis fades or a good vaccine becomes available.
• Medium-term; Negative: US Dollar –  But there is room for significant downside for both equities and the dollar if Congress disappoints.

In some ways the September employment report portrayed the US labour market as still improving, if at a disappointingly sluggish rate. Payroll employment rose by 661,000 workers versus a forecast 850,000 gain, and the unemployment rate dropped a larger-than-expected 0.5pp to 7.9%. Temporary layoffs, which have accounted for the bulk of unemployed people, dropped 1.5 million to 4.6 million, or a quarter of the April peak.

But Beneath the Hood…

Most of the rest of the report – the stuff below the surface – was rather more downbeat and points to rising downside risks if Congress cannot pass a new comprehensive stimulus program.

The lower-than-forecast payroll employment was entirely due to a sharp decline in government payrolls by 216,000 workers. That is surely the tip of the iceberg if Congress includes no aid for revenue-strapped state and local governments in any forthcoming stimulus legislation. State and local governments employ about 23 million workers, of which about 1.1 million have been laid off so far. Estimates of potential job losses vary, but published reports and back-of-the-envelope calculations suggests that additional government layoffs could be in the range of 3-5 million workers.

The drop in the unemployment rate came not from unemployed people returning to work but from them being removed from the labour force and therefore the ranks of the unemployed. This resulted in a surprising drop in the labour force by 695,000 workers. Had those people been counted as unemployed, the unemployment rate would have been 8.3%, or little changed from August. This is all the more remarkable given that the labour force is still 4.4 million workers or 2.7% short of the January 2020 level.

And, the drop in temporary unemployment was mostly due to workers either becoming permanently unemployed or dropping out of the labour force. About 20% were recalled to their jobs, 25% converted to permanent unemployment, and the rest are no longer counted as part of the labour force.

Structural Unemployment Is Rising

Our working assumption is that virtually everyone who was in the labour force in January 2020 would still be there but for the peculiar circumstances of the coronavirus crisis and the labour department’s oddball methodology for determining the labour force.^[1] We therefore assume that the true labour force remains at the pre-pandemic level and calculate the unemployment rate relative to that benchmark.^[2]

After making rapid gains during the summer as the economy partially reopened and furloughed workers were recalled, true unemployment rate flatlined at 10.5% in September (Chart 1).

We also calculate a structural unemployment rate by subtracting temporary unemployed people from the total, since there is still some prospect they could return to work in the near future. That measure dropped gradually from 7.8% in April to 6.8% in August, but then jumped back to 7.8% in September. Historically, structural unemployment recovers only gradually after a recession. After the GFC, structural unemployment peaked at 9% in April 2010 and took seven years to drop to the pre-crisis level of 4%. This time around, if structural unemployment continued to drop at the rate it did through August 2020, it would still take about 2.5 years to reach 4% and 3.75 years to reach the February 2020 low of 2.8%.

It is impossible to say whether or to what extent past patterns apply to this recession and labour market. If the virus somehow disappears or a good vaccine becomes available, the labour market and broader economy could return to normal quite rapidly.

Weekly Jobless Claims Numbers Are Worse Than They Appear

The weekly jobless claims data also continues to paint a gloomy picture. Initial weekly claims continue to come in the 800,000-900,000 range, more than four times the pre-Covid level. The flipside is that continuing claims have dropped over the past month, by 1.5 million people. It is tempting to conclude that people are going back to work rather than being laid off.

But the September labour report also revealed that people unemployed for more than six months jumped by 781,000. Unemployment benefits generally end after six months, meaning that half the decline in continuing claims was presumably due to people losing benefits rather than going to work. September was just the beginning. Some 5 million people now receiving unemployment benefits will cross the 26-week milestone over the next two months.

Absent More Fiscal Stimulus, Downside Risks Are Growing

Back in March when the CARES Act^[3] was signed into law, expectations were that the coronavirus would have run its course by the time most of its provisions expired at the end of July. The stimulus has largely been spent, and the coronavirus of course is still spreading untrammelled.

It is widely acknowledged that the prompt and massive CARES Act stimulus did much to cushion the economy and unemployed people from the worst of the coronavirus lockdowns (although parts of the economy were clobbered, including brick-and-mortar retail, travel/leisure, and restaurants).

Absent a new comprehensive stimulus bill, the benefits of the CARES Act could soon fall by the wayside. Without a resumption of the Paycheck Protection Program, extended unemployment benefits, and funds for state and local governments, the labour market and broader economy will take yet another major hit. Both temporary and permanent unemployment are sure to rise again. Based on announced layoffs and expected government cutbacks, our measure of true unemployment could soon rise by 4 million or more workers, resulting in a true unemployment rate of 13%. (Keep in mind that if the Labour Department drops most of those workers from the official labour force the headline unemployment rate might well be little changed).

Our best guess now is that there will be another fiscal stimulus bill. But, at this writing, it is highly uncertain when it will come. It could be before the election, or it might not happen until after the next president is inaugurated. And the shape of the package is up in the air. Democrats and Republicans are far apart on their priorities, and it remains to be seen whether it comes in a comprehensive package or piecemeal fashion. All of these possibilities have different implications for the labour market and economy.

Granted, there is little upside for either the labour market or economy or financial markets for passing a comprehensive stimulus bill as long as the coronavirus crisis rages – other than avoiding major downside risks. But there is also little question that the smaller and later any stimulus bill, the greater the downside will be.

1. The labour force is defined as the employed plus the unemployed. To qualify as unemployed, one has to have been actively looking for work within the past four weeks. As we have noted in previous reports, normally during recessions the labour force simply stops growing in line with population growth until a recovery commences, but it does not outright shrink. It is unclear why the labour force declined so precipitously this year when Covid-related lockdowns went into effect, other than that it was impossible to look for work, and the Labor Department survey apparently does not include questions that allow for circumstances such as a pandemic. ↑

2. We calculate the level of unemployed people as official unemployment (12.6 million) plus the difference between the labour force in January 2020 (164.6 million) and September 2020 (160.1 million). ↑

3. Coronavirus Aid, Relief and Economic Security Act of 2020. ↑