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By New_Deal_democrat October 11, 2016 12:38 pm
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Is a stabilizing unemployment rate a precursor to recession?
One of the increasing meme's I've read on Doomer sites is that, because the level of initial jobless claims, or the unemployment rate, is so low, they are actually harbinger's of recession.  One such commentator has gone so far as to claim that jobless claims are "in a bubble" -- for about the last two years!
 
So, are low, especially low and steady, jobless claims or an unemployment rate, leading indicators for recession?  Let's check it out.  In this post I will deal with the unemployment rate.
  
First, here is a look at the unemployment rate since the inception of the series in the 1950's:   
 
  
In general it certainly does look like the unemployment rate flattens out before rising into a recession.  To get a better view, let's look at the YoY change in the unemployment rate.  when the YoY change turns positive, does it always signal a recession?  Let's take a look:
 
 
While it is certainly true that the YoY change in the unemployment rate turned up going into all 10 of the last recessions, notice that it also gave at least 6 false positives (2 in the 1950s, 2 in the 1960s, 1 in the 1980s and 1 in the 1990s, along with a very close call in the 1970s).  Furthermore, even in the case to true signals, in 5 of the 10 recessions, the YoY rate never turned positive until the recession actually began!
 
Suppose we try to eliminate the false positives, by tweaking the model to require that the YoY unemployment rate be 0.5% higher?  We do eliminate the false positives, but we also eliminate any leading qualify.  Typically this tweak does not turn positive until the recession has already started:
 
 
Suppose on the contrary we try to get a more consistent leading signal, by tweaking the model to only require that the YoY unemployment rate be down by -0.5% or less?  Here's that result: 
 
 
This version gives false positives almost half of all the time that the economy spends in expansions!
 
The bottom line is that even a low and relatively steady unemployment rate by itself is not a reliable metric.  At best we can say that when the YoY change of the unemployment rate approaches changing from negative (a decreasing rate) to positive (an increasing rate), there is an elevated risk of recession in the near future increases until, by the time the YoY change is 0.5% higher, it is virtually certain that we are already in recession.
 
Finally, let's zoom in on the last 12 months:
 
 
As of September, the YoY change in the unemployment rate is -0.1%.  This is consistent with increased recession risk in the near future -- but by no means with a recession now.
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