US Watch
Group Economics Macro & Financial Markets Research
23 June 2016
The retreat of the Fed’s labour market conditions index
have weakened in the past five months, albeit at a different pace
Maritza Cabezas Senior Economist
Two broad metrics that capture the conditions of the US labour market
Tel: +31 20 343 5618
Despite the loss in momentum, Chair Yellen still sees a healthy labour market; other labour market indicators are still flashing green
maritza.cabezas@nl.abnamro.com
We think that gains in nonfarm payrolls should recover, lifting the labour market conditions index, but will likely hover a bit below the average reported in the past year
The Fed’s metrics to assess conditions in the labour market Against the backdrop of the recent weak jobs market report, we think the slowdown in the jobs market warrants more attention. In a speech in Jackson Hole in 2014, Chair Yellen mentioned that she looked closely at two indicators that capture the labour market conditions. The first, the Fed’s Board Labour Market Conditions Index (LMCI), which includes 19 indicators, to a large extent included in the labour market report published by the Bureau of Labour Statistics. Among the indicators included are the payroll employment, labour force participation rate, workers classified as part time for economic reasons, hires and quits. The index does not include job openings, or data derived from business and consumer surveys that assess the pulse of economic activity. The second gauge Yellen said she followed closely, is a related index on the labour market published by the Federal Reserve Bank of Kansas. This metric includes 23 indicators and adds some of the employment surveys, such as ISM manufacturing employment that was omitted by the previously mentioned metric. In both indicators, a positive value indicates that it is above the long-term average.
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US Watch The retreat of the Fed’s s labour ma arket conditiions index- 23 June 20116
Labour market co onditions dete eriorating Index mom mentum 2
30 3 2 20 1 10 0 -1 10 -2 20 -3 30 -4 40 -5 50
1 0 -1 -2 -3 -4 -5 92
95
98
02
Federal Reserve Board B (lhs)
05
08
12
15
Feederal Reserve Bankk of Kansas (rhs)
Source: Thomson Reuterrs Datastream
een the two me etrics Explaiining the dive rgence betwe Both indicators sugg gest that conditions in the la abour market aare deteriorating since the beginn ning of the yearr. However, the e pace at which h they are deteeriorating is diffferent.
On the one h and, the differe ences could be e attributed to m methodology. The T inputs of
ed Board’s mo odel are de-tre ended, while the other is onnly a measure e of the first the Fe differen nce and thereffore has weake ened much les ss. Another esssential feature of the Fed Board's s index is thatt is places grea ater weight on movements w which are high hly correlated with ea ach other.
Other differen nces are relate ed to the composition of thee broad indices s. Lately, the
ors that have b been included in the Federal Reserve Bankk of Kansas' in ndex, but not indicato in the other index, h have been muc ch more positive, including eemployment su urveys. As a result of o all this, the divergence be etween both ind dicators that m make up the co omposite has been in ncreasing in the e past five mon nths Is the labour l markett conditions in ndex effective e in predicting g a downturn? Historic cally, the LMC CI has fallen to o negative territory on severaal occasions. This T has not always s led to a recesssion. A negative LMCI has signalled s a reccession in 40% % of the time. Howev ver, since the 1980s all rece essions in the US have beeen preceded by y a negative LMCI. It’s fair to say tthat from all the components of the LMCI, nnonfarm payrolls shows the highest correlation w with the broad index, sugges sting that nonfa farm payrolls on o its own is also a relatively good d indicator for gauging the business cycle11. History sugg gests that six months s before a reccession, payro olls fall to an average a of 1660K, reporting at least two months s of nonfarm p payrolls below 100K. Most other o componeents are laggin ng the LMCI. Howev ver, since 2013 3, the unemplo oyment rate has also madee large contribu utions to the improv vement of the b broad index.
1
Th his can be observved by decomposing the change in LMCI into contribuutions from each indicator, i holding the remaining indiicators constant.
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US Watch The retreat of the Fed’s s labour ma arket conditiions index- 23 June 20116
Gains s nonfarm pa ayrolls and im mprovement in LMCI Index
000s 600
30 20 10 0 -10 -20 -30 -40 -50
400 200 0 -200 -400 -600 -800 76
82
88
93
Federal Res serve Board (lhs)
99
05
11 1
Nonfarm payrolls p (rhs)
Source: Thomson Reuterrs Datastream
cations for the e Fed Implic The im mplications of tthe downward d trend of the LMCI in the ppast five month hs, however, have been b almost n neglected by Fed F policymak kers. Their reccent communic cations even sugges st that they stiill see an imprrovement in the e labour markeet. Chair Yellen mentioned during the press con nference after the June FOM MC meeting, tthat the LMCI is a kind of experimental researcch, trying to pla ay down its role e. This is in shharp contrast to o her view on this ind dicator when tthe LMCI was stronger. She added during the press con nference that other indicators i of th he labour mark ket, including jobless j claims and job open nings are still improv ving, although sshe has pointe ed to some dow wnside risks thhat domestic de emand could falter. The April’s F OMC minutes suggested th hat most particcipants though ht that if the economy improved, tthis could supp port labour market conditionss strengthening g, with only a few me entioning that sslower growth could have a negative n effect on the labour market. This is unde erstandable sin nce the labour market lags ec conomic activity ty. Our viiew Our ba ase case for 2 2016 is that no onfarm payrolls s will increase at a more mo oderate pace than in the past ye ear, while une employment should stabilisee. We are mo ore cautious regard ding the labour market given that we see that the US econnomy is slowin ng and with it profit growth g has wea akened compa ared to the prev vious years. G Going forward, the t impact of a stron nger USD and falling prices on o profits will slowly fade, whi le we expect output o growth to rem main moderate e in the secon nd half of the year, basicallly driven by consumption. c Consu umption growth h has been more upbeat lattely. If consum mption growth continues to improv ve, this should lift domestic demand. d On ba alance, the chaances of a rebo ound in profit growth h rand strong hiring remain n limited in th he coming couuple of quarte ers. This all sugges sts that job gro rowth should recover r and ho over a bit beloow the average e reported in the past year.
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US Watch The retreat of the Fed’s s labour ma arket conditiions index- 23 June 20116
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