The state of the labour market occupies a central role in the analysis of the business cycle. Historically, the percentage of months over the past 12 months with nonfarm payrolls below the 200K threshold increases in the run-up to a recession. Today, this indicator stands at 0 percent. Although there have been many false signals, a significant increase in this percentage calls for vigilance, necessitating closer monitoring of other data as well to assess the risk of recession. An alternative approach consists of making the link between monthly payrolls and the unemployment rate. However, given the latest data on job creations, a swift increase in the unemployment rate sufficient to trigger a recession signal seems unlikely. This means that the slowdown of wage growth and, more broadly, the decline of core inflation, might take more time than expected, forcing the Federal Reserve to keep policy rates high for longer. This is not exactly what is being priced by financial markets.
The state of the labour market occupies a central role in the analysis of the business cycle because it reflects the state of health of firms -are they creating jobs or shedding labour?- and it drives household income and confidence. It is even more closely scrutinized around cyclical turnarounds. In the US, of the six indicators that the NBER business cycle dating committee uses to determine cyclical peak and trough dates, two relate to the labour market: nonfarm payroll employment and employment as measured by the household survey[1].
According to the Sahm rule, the US economy enters a recession when the three-month moving average of the national unemployment rate (U3) rises by 0.50 percentage points or more relative to its low during the previous 12 months[2].
US : Real-time Sahm rule recession indicatorAs shown by chart 1, the recent evolution of this indicator causes concern -it has increased- but also brings some relief because we are still below the critical threshold. These different indicators imply that in coming months, the pace of job creation will be particularly important in the assessment of the recession risk, either directly -in the NBER’s set of indicators- or indirectly, through the influence on the unemployment rate.
Establishing a link between the monthly nonfarm payrolls and the likelihood of entering recession is not straightforward. In what follows, two approaches will be discussed. The first one looks at the frequency of low job creation numbers, based on the rationale that one bad number could be considered as a one-off, whereas several low numbers could fuel recession fears.
Chart 2 shows the percentage of months over the past 12 months with nonfarm payrolls below the 200.000 threshold.[3] Historically, this percentage has increased in the run-up to a recession but there have also been false signals, whereby a significant increase in the indicator was not followed by a recession. This was, amongst others, the case in 1986, 1996, 2013 and 2018.
US: percentage of months (over the past 12 months) with nonfarm payrolls below 200KTable 1 focuses specifically on the 12 months in the run-up to a recession and shows a great diversity across cycles. The recession that started in November 1973 was preceded by a low percentage of payrolls below 200K. The one starting in December 2007 already had a high percentage of job creations below 200K 12 months earlier. For the current situation -no payrolls below 200K in the past 12 months-, the months leading to the January 1980 and March 2001 recessions should be kept in mind: starting from a very low level, the percentage of below 200K job creations increased steadily and eventually the economy entered a recession. To conclude on this point, given the diversity of situations seen in the past, this indicator should be used with caution. However, a significant increase in its value calls for vigilance, necessitating closer monitoring of other data as well to assess the risk of recession.
US: percentage of months (over the past 12 months) with nonfarm payrolls below 200K
An alternative approach consists of making the link between monthly payrolls and the unemployment rate, the idea being that a lasting increase of the latter would, based on the Sahm rule, signal a recession. Table 2 shows the employment status of the US civilian population of working age.
US civilian population: employment status
According to US Census data, the civilian noninstitutional population[4] is expected to increase 0.51 % between December 2022 and December 2023.[5] Assuming a constant labour force participation rate of 62.3%, this would imply a labour force of 165,812 million (table 3). An increase of the unemployment rate with 0.5 percentage points to 4.0% by December 2023, would correspond to an employment level of 159,180 million, i.e. a decrease of 63 thousand jobs compared with December 2022. One should keep in mind that the employment level that is used to calculate the unemployment rate is based on the household survey, whereas the nonfarm payrolls report is based on a different survey, the establishment survey.[6] The monthly changes in the two employment series are highly correlated, although in the short run there may be large differences. Based on a linear regression, a decrease of 63 thousand jobs in the household survey is expected to correspond to a decrease in the level of nonfarm payrolls with 21 thousand.
US: Simulation of employment level for a given increase in the unemployment rate
This analysis leads to two important conclusions. One, given the latest data on job creations -223 thousand new jobs in December-, a swift increase in the unemployment rate sufficient to trigger a recession signal based on the Sahm rule seems unlikely. It would require a significant slowdown in activity with a very negative impact on monthly payroll numbers[7]. Two, in the absence of a recession, a slowdown of wage growth and, more broadly, a decline of core inflation, might take more time than expected, forcing the Federal Reserve to keep policy rates high for longer. This is not exactly what is being priced by financial markets.
William De Vijlder
