At Last, Employment Seems to Be Stabilizing

Last week was a banner week for positive employment news, which should serve to bolster consumer confidence and eventually consumer spending. We continue to hold our view that the economy will hit its bottom sometime in the second quarter and that although unemployment is rising at a slower rate than before, it will peak later this year in the 9%-10% range.

Because of the high unemployment rates and poor factory utilization rates, we believe that we will not see inflation rise much above 1%-2% over the next 12-24 months. Over the next five years, we believe that the inflation rate could move up some due to increasing government deficits and an accelerating economy. However, we are not panicked by the prospect of runaway inflation. A combination of low Asian wages, improved productivity, and higher interest rates could act as significant moderating influences on the inflation rate.

Turning to the data, initial claims, the most leading of the employment indicators, posted its fifth straight week of improvement. On a raw number basis, the number of new claims has now fallen from 674,000 on March 28 to 601,000, a decline of more than 10%. The four-week moving average, which tends to smooth out the week-to-week volatility, has also shown consistent improvement. This indicator typically peaks a month or so before the bottom of the economy. Given that we peaked in late March, the economy could potentially have bottomed in late April or early May. The Challenger, Gray and Christmas Layoff Report showed dramatic improvement, with reported layoffs declining from 150,411 in April to 132,590 in March--down from a peak of over 240,000 earlier this year. This indicator is based on announced layoffs and not actual firings, so it has the potential to lead even our initial claims metric. This Challenger, Gray and Christmas survey and the Watson Wyatt layoff intentions survey (reported in April) both bode well for a better employment situation in the months ahead.

We are also modestly bullish on employment going forward because of the recently announced productivity data. In the first quarter, productivity increased 0.8% (on a seasonally adjusted rate compared to the prior quarter) after a very modest decrease in the fourth quarter of 2008. Productivity this cycle has declined less than in the past seven recessions, as employers slashed employment in front of declines in output. Even before the recession, employers were already running very tight ships, so we believe that once this cycle turns there is the potential for employment to pick up more quickly than we are currently anticipating.

The more concurrent data also showed some nice improvement. On Wednesday the ADP report showed job losses for April improved sharply. The report foreshadowed a nice improvement in Bureau of Labor Statistics report on Friday that showed an official non-farm job loss of 539,000, again down nicely from the prior month and from its January peak of 741,000. All of these numbers are high but have started to show some improvement, typical of a recovery in the economy.

The unemployment rate ticked up to 8.9% for the month of April, from 8.5% in March. However, as we noted in early May, this is a lagging indicator. By the time this indicator peaks, we could well be in a booming economy. Part of the reason for the lagging nature of this indicator is that more people tend to enter the job market as things begin to improve. In fact, we saw that effect this quarter as 683,000 new job seekers entered the market in April.

So with unemployment rates going up, why has the consumer shown some decent strength in the first four months of the year? With job losses so high, how can the consumer afford to spend more? The key to this puzzle is that even today 91% of the people who want jobs, have jobs. The attitudes and wage increases of this 91% majority far outweigh a 1% or 2% change in the unemployment rate. Mathematically, if the 91% of the population increases spending by about 1%, it completely offsets a 1% move in the unemployment rate. That increased spending could come from wage increases, less savings, or potentially more debt. Keep in mind too, that unemployment insurance on average replaces about half of normal income.