[Financial Planning for the 100-Year Life] The Implications of the Rising US Unemployment Rate

Rising Unemployment Rate Indicates Economic Growth Slowdown
Stock Prices May Adjust Even If Market Interest Rates Fall

As nonfarm employment in the United States increased by 275,000 in February, U.S. employment has maintained a steady growth trend until recently. However, the unemployment rate in February this year reached 3.9%, the highest in 2 years and 1 month since January 2022 (4.0%). The rise in the unemployment rate indicates that the U.S. economic growth rate will soon slow down. Although market interest rates are expected to fall due to the slowdown in economic growth, stock prices are likely to undergo a correction. The value of the dollar is also likely to decline.

Since the unemployment rate hit a record low of 3.4% in April last year, it has been gradually rising. Looking at long-term statistics since 1953, the 12-month moving average low of the unemployment rate has preceded recessions by an average of 2 months. However, the 12-month moving average bottomed at 3.55% in May last year and slightly rose to 3.68% in February this year. Although the lead time is longer than the historical average, this suggests that a recession phase may begin soon.

Consumption accounts for a very high proportion of the U.S. Gross Domestic Product (GDP), at 69% as of 2023. The U.S. economy is absolutely dependent on consumption. When the unemployment rate rises, consumer sentiment first contracts, and actual consumption decreases with a time lag. Among the representative consumer sentiment indicators in the U.S., there is a very strong inverse correlation between the Conference Board Consumer Confidence Index and the unemployment rate. Analyzing statistics from January 2000 to February this year, the correlation coefficient between these two variables was -0.78. Despite major U.S. stock indices reaching record highs in February, the deterioration in consumer sentiment appears to be due to the rise in the unemployment rate.

U.S. employment is very flexible. When consumption sharply contracted due to COVID-19 in March-April 2020, U.S. companies cut 21.89 million jobs. This means that jobs that had increased for nearly 10 years were reduced in just two months. If household consumption contracts as the unemployment rate rises, corporate sales and profits may decline. Then, U.S. business managers are likely to reduce employment flexibly. This, in turn, reduces consumption and could push the U.S. economy into a recession. As early as the second quarter of this year, the U.S. economy may experience negative growth centered on consumption.

When consumption contracts due to rising unemployment, inflation rates decrease. Market interest rates first reflect economic growth rates and inflation rates. Along with the rise in unemployment, market interest rates will soon fall. The 10-year Treasury yield, which rose to 4.32% at the end of February, fell to 4.07% after the February unemployment rate announcement. The Federal Reserve (Fed) is likely to cut the benchmark interest rate as early as May, and market interest rates may fall further.

Generally, when interest rates fall, stock prices rise. However, if the decline in corporate profits, another key factor determining stock prices, is greater than the drop in interest rates, stock prices may fall despite the interest rate decline. The unemployment rate is one of the representative indicators of the economy. Analyzing statistics since 2008, the correlation coefficient between the unemployment rate and the S&P 500 was -0.63, which is relatively high. This means that stock prices fell when the unemployment rate rose. Of course, in some periods, stock prices often led the unemployment rate. Recently, stock prices have risen despite the rising unemployment rate. A correction in stock prices is expected soon, narrowing this gap.

During periods when the unemployment rate rises, U.S. interest rates fall and the value of the dollar also declines. In fact, statistical analysis from January 2008 to February 2024 shows an inverse correlation (correlation coefficient -0.66) between the unemployment rate and the dollar index. In this sense, the U.S. unemployment rate provides important implications for asset allocation. If the proportion of U.S. investment assets is high, it may need to be reduced. Also, expanding the proportion of bonds rather than stocks seems more desirable.

Kim Young-ik (Adjunct Professor, Graduate School of Economics, Sogang University)