Markets take the unemployment rate decline more seriously than warranted

The unemployment rate is still likely to reach a new high, probably at or at least approaching 11.0%. The economy will reveal new signs of profound weakness amidst the evidence of economic recovery. Indeed, there is a risk of a return to at least one quarter of negative real GDP growth next year, most likely in the second half. That was the pattern in most post World War ll recessions. Moreover, the Dubai world credit default is just an early indication of a broadly developing commercial real estate debacle encompassing hotels, apartments, offices, retail space and gaming facilities. Employment connected to stimulus construction projects is already topping out and will soon be waning. The January, February retreat in retail sales, after the holiday shopping season, will be more pronounced than typical. That and other economic negatives are implicit in a recent decline in instalment credit and other evidence of continuing or tightening availability of credit to consumers. There is still a new wave of home foreclosures developing, despite the signs of a housing recovery. Treasury yields will decline anew. Commodity and equity prices in such an economic environment will more likely retreat than advance further, even with a continued low cost of financing.

The decline in the November unemployment rate to 10.0% from 10.2% in October and the relatively miniscule 11,000 November decline in nonfarm payrolls does not mark the beginning of a sustained rise in employment or a quickening in the still sluggish pace of economic recovery. And it is certainly not an indication that the economy is no longer vulnerable to a relapse or that the Fed will be firming any time soon. Instead, it is more than likely that the November unemployment rate decline is due to improper seasonal adjustment, partly as a result of a large cyclical decline in employment a year earlier as well as in the prior month. The rise in the unemployment rate to 10.2% in October 2009 from 9.8% in September may well have overstated the actual rise. Thus, the November unemployment decline may have been a form of partial correction of the prior unemployment overstatement. There is also insufficient reason to believe that the unemployment rate has cyclically topped out. The decline in service sector employment suggested by the puchasing managers report is just the latest suggestion of more employment problems ahead, even with the recent moderation in the pace of initial claims for unemployment benefits.

Despite serious questions over the significance of the November employment report the markets responded as if there were no doubt over its meaning. The dollar strengthened as if the economy was vigorously rebounding. It is not. But the dollar rise led to a decline in gold prices and a further rise in equity prices. Treasury prices retreated as if it were now a foregone conclusion that the Fed would soon be firming. Instead Fed policy will continue accommodative for an extended period, probably all through 2010 at the very least. There is no immediate or even near-term inflation risk, not with current massive unemployment as well as a huge volume of idle industrial production and service capacity restraining both wage and price increases.

At current levels of unemployment and capacity utilization rates, the US economy is as far from wage and "Bottle neck" price pressures as it has been at any time since the great Depression of the 1930's. Indeed, though the overall official unemployment rate at 10.0% in November is under the previous post-World war ll peak of 10.8% in November and December 1982, the official unemployment rate by education levels is significantly higher currently than at the peak in 1982. For example, for high school drop-outs the current unemployment rate is 14.9% versus 13.6% at the peak in 1982. For college graduates the unemployment rate is now 4.9% versus 3.6% in 1982. In addition, counting discouraged workers (who have given up looking for work because there are no jobs to be had) and those who have taken part-time work because they could not find full-time employment, the U-6 unemployment rate, at 17.2%, is still near a record high. That will keep both inflation and the Fed at bay.

Treasury yields rose sharply after release of the deceptive Friday unemployment report. The 10-year note yield, for example, reached 3.48% from 3.38% the day before, and 3.20% just days before amidst the Dubai credit fright. However, the yield on the Treasury 10-year note had approached 4.00% as recently as August. The pressure of new supply of Treasury borrowing coming next week and relentlessly thereafter, for as far as the eye can see, is of course also an important factor in the rate rise. Despite all that, the outlook is still favorable for a renewed and significant decline in Treasury yields, as it becomes clear that deflation pressures persist and an upsurge of inflation is only a distant threat. That was the pattern in most previous economic recoveries. Contrary to preconceived notions, the cyclical lows in Treasury yields came well into economic recoveries, not in the midst of the recession as is widely, but mistakenly, believed.


Philip Braverman, President
Braverman Economic and Financial Consulting
One Hewitt Square #249
East Northport, New York 11731

This and earlier reports can be accessed by going to Internet Explorer and typing the following:philipbraverman.blogspot.com

I can be reached at philipbraverman@gmail.com