Monday, June 5, 2017

YoY job growth and the Fed funds rate

 - by New Deal democrat

Continuing with a more detailed look at the current employment situation, one of the least noisy series - that also has a very long history - is the YoY% change in payrolls:

In general YoY payroll growth increases until about midpoint in an expansion, and then decelerates until finally turning negative shortly into the next recession.

So the first thing to note is that YoY employment growth peaked in early 2015, and has been decelerating ever since.

But there are several counterexamples -- notably the 1960s, 1980s, and 1990s -- where YoY employment had several peaks. That's what I want to take a further look at today.

All three of the above counterexamples coincided with expansions in which there were also multiple Fed interest rate cycles.

Just how close is the match?  Take a look at YoY payroll growth (blue) compared with the YoY change in the Fed funds rate (red):

There were at least 3 notable peaks in the YoY change in the Fed funds rate in the 1960s, and two each in the 1980s and 1990s. And they correlated quite well -- within several months -- of both the peaks and troughs in YoY job growth.

In fact the relationship is decent enough that, as a general rule, when the YoY change of the Fed funds approaches or exceeds YoY job growth, the expansion is in trouble (with 1994 being the only exception).  Note that in all but two of the above cycles, the YoY change in the Fed funds rate was +2% or higher:

The exceptions were 2000, with a 1.75% YoY increase in Fed funds, and 1955, with a 1.5% increase. The 1955 exception is particularly noteworthy, since that was also a case where the yield curve never inverted.  This underscores the point that one cannot rely upon and increase in short term interest rates as the primary determinant of when an expansion in a deflationary era will end.

To return to my main point, I emphasize that I'm not claiming any causal relationship here, just that the same underlying reasons that give rise to the Fed tightening and loosening have historically also similarly affected employment growth.

Which brings me to the current expansion.  Here's a close-up:

The current situation violates the paradigm since 1955 in that there was no increase in the Fed funds rate as the rate of job growth rose.  Now, in a negative development, we have increasing interest rates in the face of declining YoY employment.  But we still haven't had enough of an increase that would have correlated in the past 60 years with an oncoming recession.

If the Fed should raise rates again later this month, it will certainly be problematic.  Will the Fed reverse quickly enough should there be a further stumble in employment, to extend the expansion, as in the 1980s and 1990s? Frankly, I doubt it, but we'll see.