As the unemployment rate creeps lower and lower and approaches the Federal Reserve's goal of 6.5% it continues to spark fear over whether the Federal Reserve will be ending QE sooner than expected. Today, this fear was diminished slightly because the unemployment rate was reported at 7.6%, slightly higher than expected. This actually lifted the markets because fears of QE ending soon were diminished. This all seems rather backwards, the market rallies on higher unemployment. Market reactions like this show just how strong the Fed's role in the market is and how closely its actions are watched. Fortunately for investors I believe the unemployment rate has hit a roadblock and will have a much harder time decreasing further. Most likely, this means the Fed will not start tapering QE any time soon.
A Look at Unemployment (source: Bureau of Labor Statistics)
The unemployment number most people watch carefully, U-3 in the Bureau of Labor Statistics Table, does not give a completely accurate portrayal of unemployment. This measure is called the total unemployed as a percentage of the civilian labor force. However, it leaves out several important categories. First, it leaves out discouraged workers. Discouraged workers are people who have been unemployed for a long time and have simply given up looking for a job. This is why they are called "discouraged." Another category left out is "persons marginally attached to the labor force." These people do not have a job and indicate that they want a job but are not looking very actively. They have only looked sometime in the past 12 months. Lastly the official unemployment rate does not include people working part time for economic reasons. These people would like to work full time but can only manage to find part time work. The Bureau of Labor Statistics is not trying to trick anyone, in fact a measure with all these people included is available; it is U-6. Currently the percentage of people unemployed including these categories is 13.8%.
Why is this Important?
If you simply looked at the unemployment rate you would predict that if a certain number of jobs were created the unemployment rate would decrease a certain amount. However, these other categories almost act as resistance to the unemployment rate falling because many of these people will rejoin the workforce as the economy improves, especially the category of people working part time for economic reasons. I would expect this category to soak up some of the new jobs before the actual unemployed. If you compare the U-6 to the unemployment rate in 2007 the difference is only about 3%, currently the difference in these measures is roughly 6.5%. This suggests that this pool of people is much larger than historically and can soak up more jobs than usual.
At least part of this pool of people, not included in the official unemployment number, is likely to resume full-time employment if the economy continues to strengthen. This should prevent the unemployment rate from falling too quickly since they will be absorbing many if the new jobs. As a result the target of 6.5% unemployment may be farther away than most people think, which means the Federal Reserve is likely to continue its policies longer than expected. Before the unemployment rate drops further I expect the difference between U-6 and U-3 to decline significantly. Therefore, the spread between U-6 and U-3 is really the next thing that will indicate whether or not the economy is truly improving, and whether or not the Fed is closer to ending QE. In conclusion, the forecasts of a significant pullback in major indices tracked by ETFs like SPY may also be further down the road than initially expected.