(This commentary originally appeared on Wednesday on Real Money Pro. Click here to learn about this dynamic market information service for active traders.)
As we look forward to the jobs report on Friday, it is useful to consider what we should be expecting in terms of labor growth and unemployment. How low could unemployment reasonably fall? Who is left that could come back into the labor force? And how is the Fed thinking about all of this?
Little evidence that hiring is slowing
I've written about this many times, but I have long argued that job gains will now slow materially until the economy slows. We see no evidence that near-term growth will slow, nor that employers are slowing hiring. Survey data from ISM to NFIB have all shown solid business confidence and, specifically, solid hiring intentions. Job openings are at all-time highs. Adjusting for the size of the labor force, jobless claims are at all-time lows. Whether Friday's jobs number beats or misses the single-month expectations is anyone's guess, but there is absolutely no reason to expect hiring to slow down over the next several months.
Could Unemployment "Crash"?
New York Fed President William Dudley has been talking about unemployment "crashing" for a while now. It sounds strange to refer to a rapidly falling unemployment rate as a negative, but in context he is talking about the possibility that unemployment would fall through some threshold that could cause wage gains to move rapidly higher.
That is something the Fed would need to be vigilant about, i.e., wanting to be moving rates higher ahead of such an event. It seems this kind of thinking is part of why the Fed is intent on raising rates this December, despite some weaker inflation figures.
I don't know exactly what Dudley has in mind when he describes a "crash", but if conditions stay roughly the same, there is a very real chance that the unemployment rate falls further. Perhaps even below anything we've seen in recent decades. In the chart below, we show where unemployment could go between now and the end of 2018 under some very simple assumptions:
- Population growth equal to the average of the last 5 years (around 200,000/month);
- Labor Force Participation steady at last month's level of 62.9%;
- Job gains ranging from +120,000 per month to +175,000 per month. Note that the average of the last year has been +164,000 per month.
Source: Bureau of Labor Statistics
Note that at job gains around recent levels, unemployment will likely fall to between 4.0% and 3.8% if these assumptions hold. That would tie the lowest unemployment rates we've seen in the U.S. since 1970.
Could labor force participation keep rising?
The main caveat to the analysis above is that labor force participation could rebound further. In 2015, LFP fell as low as 62.4%, but has slowly climbed back to 62.9%. It might not sound like much, but if this gain can stick, it would create a lot more room for additional job gains without a "crash" in unemployment.
The reader is no doubt aware that a big reason why LFP has been falling is the aging of the population. In 1995, when LFP was just under 67%, about 26% of the population was 55 or older, while 25-54 year olds (so-called prime-aged workers) were 57%. Today the 55+ group is 36% and the prime-aged group is 49%. This demographic shift makes it logical that the overall LFP should fall. Only 40.1% of the 55+ crowd is participating in the labor market vs. 81.8% of the 25-54 year olds.
The best hope for some LFP rebound is to get LFP among the 25-54 group to rise. Between 2005 and 2007, participation in that set averaged 82.9%. Gaining just 1.1% in LFP from that group would add nearly 1.4 million workers by the end of 2018.
So, let's re-run the projected unemployment rate analysis holding LFP steady among other age groups, but increasing the 25-54 year olds slowly from 81.8% to 82.9%. We'll also grow the population by age group at the same pace that's been occurring over the last five years, meaning the overall population will keep aging a bit over this time period.
Source: Bureau of Labor Statistics
Now we see that gains of 150,000 to 175,000 keep unemployment around where we are today. That would be fantastic news for both risk assets and interest rates, as it would mean that the economy could keep growing without the Fed needing to raise rates much.
OK, but will this happen?
That is harder to say. The LFP among this 25-54 demographic has risen from 80.6% in September 2015 to the 81.8% percentage today, so it appears the stronger job market is indeed bringing people back into the labor force already. It is impossible to say whether it could keep expanding at this pace or if it will level off. However, it is worth noting that in the 1990s this age group's LFP was persistently above 84%. So it doesn't seem like a stretch that we get to 83%.
This analysis paints a fairly rosy picture. Job gains can continue at a pretty robust level without creating a problematically low unemployment rate, so long as the labor force keeps growing. Obviously, there are a lot of variables here, and so plenty could get in the way of this coming to fruition. But the good news is that we have room for robust job gains.
The bad news is that we probably need to keep seeing job gains. I have written in the past that historically economies can hit a "stall speed" that is evident in employment gains. If history is an accurate guide, that level right now is around +160,000 jobs/month, roughly where we've been the last 12 months. I believe that if job gains fall much below that, it would suggest that an economic slowdown is imminent. I don't think that's about to happen, but that's what I'm watching.