In recent months, a growing debate has appeared asking if the U.S. unemployment rate (U-3, the official unemployment rate) is indicating the economy has reached or nearing full employment.
"Full unemployment" is often defined as "the level of employment at which virtually anyone who wants to work can find employment at the prevailing wage." (Source)
Full employment should not be confused with zero unemployment. At any given time there is usually some percentage of labor participants who are unemployed for various reasons. Hence, full employment is not a zero rate of unemployment, but full employment is considered a natural rate of unemployment which may change over time.
This analysis examined only the behavior of the monthly U-3 data from Jan 1948 to April 2017. A little over 68 years of monthly data.
Yes, there are multiple factors that may influence the direction of the U-3 unemployment rate such as interest rates, inflation, government policies, the labor force participation rate, mismatch of skills to demand, structural changes in the labor market and other macro-economic themes.
However, this analysis is not examining the factors that may influence the U-3 rate, but simply examining the behavior and tendencies of the rate since 1948.
Some may argue the U-6 rate (the widest BLS definition of an unemployment) is a better indicator on the status of unemployment, however U-3 is the headline rate (official rate) that is frequently discussed. Therefore, this analysis focused on the U-3 rate. TheBureau of Labor Statistics (BLS) has six definitions of unemployment: U-1, U-2, U-3, U-4, U-5 and U-6.
The Unemployment Rate is Similar to a Spread
If you think of the unemployment rate as a labor market supply and demand gauge, consider it to be a mean reverting market that finds moments of overbought and oversold conditions. Think of the monthly data as a spread where it tends to be range bound and on occasion will break above or below the range thresholds. For example the highest monthly rate of unemployment was 10.8% in November and December 1982. The lowest rate was found in May and June of 1953 at 2.5%.
The first item analyzed included the average rate per respective year, the maximum monthly rate per respective year and the minimum monthly rate per respective year.
Chart 1: U.S. Average Annual, Maximum and Minimum U-3 Unemployment rate from January 1948 to December 2016. And the Differential of the Yearly Maximum and Minimum levels of U-3.
Source: Data BLS.gov
Chart 1 represents two points:
The top set of lines represents the average (in blue) U-3 unemployment rate for the respective year along with its maximum (orange) and minimum (grey) rate for the respective year. The yellow horizontal line represents the average of the average annual rates for each respective year since 1948 at 5.8%. For example in 1948 the average U-3 rate was 3.8%, the maximum rate was 4.0% and the minimum rate was 3.4%.
The blue line at the bottom of the chart is the differential between the maximum and minimum rates in each respective year. Simply asking the question, how large of a dispersion is seen each year between maximum and minimum rates and how does the dispersion tend to behave over time?
The red horizontal line is the average annual historical differential between the maximum and minimum yearly U-3 rates. For example the differential between the maximum and minimum in 2016 was 0.4%, below the 0.9% average differential rate.
What can be derived from the data?
The data notes the historical average of each year at 5.8%. Obviously there is volatility around the average. When U-3 breaks above 5.8%, it either tends to increase by an estimated 10 to 30 basis points above the average and peak within several months or it tends to move closer to 200 basis points or more and may take several months to over a year to reach a peak. 28 years (41% of the time) the average year has been above 5.8%.
The average differential between the maximum rate and minimum rate in a given year is 0.9%. 24 years or 35% of the time the max/ min spread of U-3 monthly rates is greater than the average of 0.9%. The Maximum differential was 360 basis points in 1949. January 1949 experienced the low of the year at 4.3% with the high reached in October 1949 at 7.9%. This may be a surprise as some may believe the largest differential occurred in 2008 at the start of the financial crisis.
However, 2008 by historical standards was still large at 240 basis points, followed by 2009 at 220 basis points. But much less than 1948. For the last few years the differential of the maximum to minimum has been smaller than average: 2015, 2016 and 2017 (up to April) 0.7%, 0.4% and 0.4% respectively.
The smallest differential was 0.2% or 20 basis points in 1967. September 1967 the minimum of 3.8% was reached and followed by 4.0% in October. However, the late 1960's experienced a low rate and relatively low variance of the U-3 rate. In 1968 rates reached the range of the mid to low 3%. In 1970 the differential expanded to 220 basis points from a low of 3.9% in January 1970 to a high of 6.1% in December.
The large differentials may occur in years of increasing unemployment as well as decreasing unemployment. It's a function of the magnitude of a direction (trend) in the labor markets. For example, the average is 0.9% or 90 basis points, if unemployment is rising and the year started at 5%. On average, the maximum for the year may be a bit above or below 5.9%.
Chart 2: Monthly U-3 Rates from January 1948 to April 2017
Source: Data BLS.gov
Chart 2 demonstrates how the monthly U-3 rates have cycled between its highs and lows over the decades. The average monthly rate is 5.8% (orange). One could think of it as a spread or mean-reverting market. One standard deviation above the mean is 7.4% (grey). Think of that as a resistance level. The next resistance level is 9.1% or two standard deviations above the mean. The only time the U-3 rate rallied above 9.1% was in 1982 at 10.8% and the financial crisis when it reached 10% in October 2010.
If the rate doesn't peak around 6.0%, it will usually peak around the 7.0% to 8.0% level.
On the downside, the U-3 support level is 4.2% (1 standard deviation below the mean). It often finds support in the 3.5% to 4.5% level. With the exception of 1952 and 1953 where the rate dropped to 2.5% (2 standard deviations below the mean) in June 1953. By September 1954 the rate increased to 6.1%.
Once the rate approaches the estimated 4.2% level it tends to consolidate. Perhaps a few months to a few years as the rate finds a bottom and then moves higher.
1948 U-3 remained below 4.2% for 12 months. 1951 to 1953 U-3 remained below 4.2% for 35 months. By September 1954 the rate reached 6.1%. From May 1955 to August 1957 the rate hovered around the high 3.0% range to the low 4.0% range. The rate once again stayed below 4.2% from Nov 1965 until February 1970. From October 1999 to January 2001, the U-3 rate remained below 4.2%.
In summary: the April 2017 rate was reported at 4.4%. The U-3 rate is approaching the range where it tends to find a bottom. The rate could begin to find support around this level, perhaps even continue below 4%. That was last experienced in April 2000. Prior to that we have to go back to the 1966 to 1969 period when the U-3 rate stayed below 4.0% for four years.
The point being, the low 4.0% threshold is a level the U-3 rate usually doesn't immediately rally from, but instead frequently consolidates and builds a support level . The rate could be range bound in the 3.5% to 4.5% area for several months or for a much longer period before it reverts to the mean. While this is happening the differential between the maximum and minimum rate could be less than 90 basis points this year and perhaps next year.