May 6, 2024
The downturn in the employment market is accelerating, particularly in the United States
The Fed could end up being seen as "behind the curve" in the rate-cutting cycle
When monetary policy rhetoric becomes more accommodative...
... bonds will generate particularly positive returns

CHART OF THE WEEK: "Unemployment rate and new houses inventory"


By the standards of recent decades, the unemployment rate is currently very low in both the United States and the Euro Area (see Fig. 2). This performance is more impressive on the Old Continent, where economic activity has been sluggish for six consecutive quarters. However, the recent rise in the US unemployment rate is a source of concern for investors. This anxiety is justified, given that economic growth is equal to the sum of job creation and productivity gains (GDP = employment + productivity).

Employment is crucial: the more it increases, the stronger growth will be. On the other hand, when it shrinks, recession looms. So if recent job losses continue, or even accelerate, they could jeopardise the consensus growth scenario and put a stop to the bull market. This raises the question of whether the job market is still robust or, on the contrary, whether it is deteriorating dangerously?

In a traditional economy, companies react to the capacity utilisation rate. When this rate is high, they invest in additional resources: "workforce" and "machinery". The former makes the latter run. Following the teachings of Charles Cobb and Paul Douglas in 1928, economists speak of "labour" and "capital". In econometrics, the function named after these two researchers is used to model production. The most erudite also use it to evaluate the effects of technology on labour and capital inputs, and then on production. For their part, investors use this rationale to anticipate changes in the labour market.

From a mathematical point of view, this is a simple weighted geometric average. So when the capacity utilisation rate is high, companies invest by taking on new employees and buying new machinery. In the United States and Europe, on average, when the capacity utilisation rate exceeds 77.5%, companies invest in labour and capital. Conversely, when the rate falls below this level, they stop purchasing materials and lay off staff. Between 2022 and 2024, this intensity ratio fell from 81.6% to 78.7% (see Fig. 3). It is currently compatible with very weak employment growth: +0.5% per year. Worse still, given the downward trend, the probability of employment growth remaining at 1.5% is virtually nil.

In the United States, where statistics are more detailed than in Europe, it is striking to note that the data collected from households do not indicate employment growth of 1.9%, as do those obtained from businesses, but of only 0.4% (see Fig. 4). This discrepancy can be explained by two factors:

  • On the one hand, some of the vacancies posted by companies were filled by foreign workers. However, this newly immigrated population has not yet been included in the panel of American households surveyed. This parameter gives an advantage to the reliability of the data from companies.
  • On the other hand, workers who have recently been laid off sometimes remain on the company payroll for several months, while they serve their notice period. When they are questioned, they will therefore indicate that they no longer have a job, while companies will only report the reduction in the workforce a few months later. This bias gives the household data a head start.

Although companies are sometimes slow to update their headcount data, purchasing managers are reactive when it comes to indicating whether or not they intend to recruit in the coming months. The employment sub-component of the survey compiled by the Institute of Supply Managers is currently the excesses seen during the pandemic and reopening periods, a normalisation of the link between the ISM index and the labour market is likely. Given this assumption, it is already no longer possible to expect job creation in the United States over the next few quarters.

Overall, investors should bear in mind that the labour market is a lagging indicator of the economic cycle. It is only once demand has slowed, companies have stockpiled and then stopped investing... that the unemployment rate takes off. As usual in the United States, the labour market will be two years late in following one of its most advanced indicators: the inventory of new homes (see Chart of the Week).

With economic growth and inflationary pressure stronger than initially expected, central banks have sought to delay the easing of their monetary policy. The vast majority of investors now expect the Federal Reserve to cut interest rates just once this year, compared with at least four cuts four months ago (see Fig. 6).


In the light of this labour market analysis, expectations of rate cuts have become far too modest and this cautiousness far too consensual. When hiring comes to a standstill and the unemployment rate rises, central banks will adopt a much more accommodating stance. This will allow yields to fall and bonds to generate particularly positive returns (see Fig. 7). In their wake, strategies such as steepening the yield curve, selling the dollar and buying gold will benefit.


Financial Research