Global Daily – Another slide in US unemployment?

by: Peter de Bruin

140205-Global-Daily-Insight.pdf ()
  • We examine the possible effect of the expiration of the emergency unemployment benefits…
  • …which strengthen our view that the unemployment rate will reach 6% at the end of the year
  • This is earlier than the Fed expects, forcing it to focus on other labour market variables,…
  • …and risking that markets start to price in earlier rate hikes than currently is the case

Expiration of emergency unemployment benefits…

We think we could be heading for another large drop in the unemployment rate in the coming months, even though we might see some payback for December’s weather related slide. This is because the Emergency Unemployment Compensation (EUC) Program, which provided benefits to unemployment workers who had depleted their regular benefits after 26 weeks, ended on December 28 2013. Granted, there is a chance that Congress will extend the emergency measures, though, so far, any plans for an extension seem to have stalled. At any rate, the expiration of the benefits is likely to affect this week’s nonfarm payrolls data, and most likely will continue to do so in the coming months. According to the Department of Labor, 1.3 million unemployed workers have lost EUC benefits since the start of January, while a further 1.9 million unemployed persons’ regular benefits will become exhausted in the first six months of this year, leaving them unable to transfer to the EUC Program.



…likely to drag down the unemployment rate

The expiration of Emergency Unemployment Compensation Program will exert downward pressure on the unemployment rate via two channels. Firstly, unemployed persons need to be looking for a job in order to collect benefits, giving them an incentive to stay in the labour force longer than would have been the case without the EUC Program. This is called the participation effect, i.e. part of the long-term unemployed will stop looking for a job once their benefits dry up. There is also an employment effect. As persons stop receiving benefits, they might take up jobs they earlier would have refused.

North Carolina provides some strong evidence

Interestingly, the State of North Carolina stopped its EUC Program already in July of last year, providing a first test case. Between July and December, its unemployment rate dropped by 2 pp, against a country wide fall of 0.6 pp. This reflected a 1.1 pp drop in North Carolina’s labour force, while employment rose by 1.0%. In comparison, in the US as a whole, the labour force declined by 0.6% and employment increased by 0.4%. So in North Carolina, the ending of the EUC Program led to a sharp decline in the unemployment rate, with the participation and employment effect roughly having the same impact.

Unemployment rate to reach 6% in final quarter of the year

Obviously, we should be careful in blindly extrapolating the findings in North Carolina, and most academic evidence sees a smaller impact on the unemployment rate. That said, the ending of the Program strengthens our view that the unemployment rate is set to decline considerably faster than what the Fed expects. Indeed, in this week’s nonfarm payrolls report we already expect the first impact of the ending of EUC program. While there should be some upward pressure on the unemployment rate, reflecting payback for December’s weather related fall in the labour force, this should be offset by people leaving the labour force because of the ending of the emergency benefits. Looking further out, the stopping of the emergency unemployment benefits should bring the unemployment rate to 6% in 2014Q4, which compares to the Fed’s estimate of 6.5%.

Fed unimpressed, but markets to price in earlier rate hikes

As this happens, we expect the FOMC to downplay the drop, citing that special factors are at play. Instead, Committee members are likely to stress even more the importance of other labour market variables. Alternatively, there is a chance that the Fed will lower its unemployment rate threshold. That said, we do think that the a drop in the unemployment rate to 6% at year-end risks that markets start to price in earlier rate hikes than now is the case.