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How Low Can the Unemployment Rate Really Go?

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Unemployment rate lurks at a multiyear low

The unemployment rate for June increased to 4.0% from a low of 3.8% in May, which was an 18-year low. The unemployment has grown because ~600,000 workers joined the workforce. Previously, the workers stopped looking for work. Overall, the unemployment rate could decline for two reasons:

  • More people are getting hired.
  • Discouraged people have stopped looking for jobs.

So, the increase in the unemployment rate in June due to the addition to the labor force is actually positive. Since the workers sensed better job prospects, they jumped on the hiring bandwagon.

How low can the unemployment rate go?

So, how low can the unemployment rate go? The rate hit 3.8% in 2000 as well. However, there’s a basic difference between the two scenarios. In 2000, the labor force participation rate was 67%—compared to 62.9% in June. As more people start actively looking for jobs, the unemployment rate shows a more accurate picture of the job market.

There’s always a sweet spot as far as the unemployment rate is concerned. The unemployment rate can’t practically go down to zero because there’s some level of unemployment after people leave their current jobs and look for new ones.

Unemployment rate and market consensus

According to the consensus compiled by Thomson Reuters, economists expect the unemployment rate to fall to 3.9% in July from 4.0% in June. Many economists think that even as the labor force participation rate increases, unemployment levels could be near 3.5% towards the end of the year.

The Fed is judging “full employment” as being consistent with 4.5% unemployment or lower. A level of 3.9%, as expected by economists, should be consistent with the Fed’s gradual rate hike (BND) path scenario. The level shouldn’t have much of an impact on the markets (SPY) (VTI).

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