San Francisco Fed unemployment study

Why the San Francisco Fed says the labor market’s gaining momentum

In its latest FRBSF (Federal Reserve Bank of San Francisco) Economic Letter, the San Francisco Fed examines how various economic indicators can predict future unemployment

The most important economic indicator right now driving Fed policy is the strength or weakness of the labor market. The Fed has a dual mandate to maximize employment consistent with price stability. At this moment, inflation is well contained and there’s excess slack in the economy—particularly in the labor market. Fed policymakers are monitoring these separate indicators and using them as a guide to change the pace of asset purchases, otherwise known as “quantitative easing.” In this series, we’ll look at which indicators are useful predictors and discuss why the San Francisco Fed sees reason for optimism.

MR-SF Fed 1Enlarge Graph

The model looks at indicators that most correlate with labor market expansions

The study looks at indicators that signal future improvements in the labor market, and it calculates the degree of momentum behind the recovery. From that, the Fed can make predictions about the outlook for the labor market. It looked at 30 different indicators, and six stood out as excellent predictors of future improvements in the unemployment rate. The separate factors are:

  • Insured unemployment rate
  • Initial jobless claims
  • Capacity utilization
  • Jobs gap
  • ISM Manufacturing Index
  • Payroll employment growth

All of these indicators are released publicly—or can be easily derived from public reports.

Explaining the table

In the table above, we have the unemployment rate, which is the statistic we’re trying to predict, along with the indicators below. They’re presented in order of their predictive power. The first column is the correlation between the current indicators—in other words, the correlation between negative changes in unemployment and capacity utilization or the ISM manufacturing index. The second column is the correlation between the current index and the unemployment rate six months into the future. The last two columns show what these indicators signaled about the labor market a year ago and what they signal today (a greener, more negative number indicates more predicted strength).

We’ll look at the various indicators and then discuss how they affect homebuilders like Lennar (LEN), KB Home (KBH), Toll Brothers (TOL), PulteGroup (PHM), and Standard Pacific (SPF).

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