Low Unemployment Is Not Good?

Just yesterday, the United States (U.S.) jobs report for the month of September was out.

The numbers, in short:

 

• Non-farm payrolls were up 336,000 against the expected 170,000.
• Unemployment rate was fairly constant at 3.8%
• Labour force participation remained unchanged at 62.8%.

 

The U.S. market’s reaction was quick; within moments of the report’s release, the yields of the U.S. treasuries and bonds rose, the index futures went down and the U.S. dollar had strengthened.

 

To a layman, having a low unemployment rate is good, which is a healthy sign of the economy in general. However, in the current context of high inflation, this is not a good sign.

 

And yes, that not-so-good-sign comes in the form of interest rates.

 

Of Hypotheses And Theorems

 

Economics and markets in general are paradoxical; we can use hypotheses and theorems to explain certain relationships, yet they are not totally valid and reliable in explaining everything.

 

One of the macroeconomic concepts out there is the Philips Curve, which stated that there is an inverse relationship between inflation and unemployment. This meant that when unemployment goes down, inflation goes up, and vice versa. Though sound, the Philips Curve did not manifest much during the 1970s when the U.S. experienced high unemployment and high inflation, becoming what was known as stagflation.

 

Another view is that higher participation in the labour market implies heightened economic activity in the form of increased incomes and demand, which in turn could drive inflation higher; this can be explained from the simple demand-supply curve.

 

Now you know why the markets reacted as described in the previous section when the jobs report came out.

 

In gist, when unemployment is low, it hints that inflation is, ceteris paribus, still high, which in turn the Federal Reserve (the U.S. central bank that governs interest rates) would, barring any other conditions, either raise interest rates or remain them as at the current level. High interest rates are no good for the equities markets and long dated bonds, but good for holding the U.S. dollar.

 

Note For The Bedokian Portfolio Investor

 

Such macroeconomic stuff sits at the top level of the Bedokian Portfolio’s  fundamental analysis model, which is economic conditions¹. While these things are beyond our control, it is good to know and acknowledge them so that you can have a situational awareness of your investment portfolio going forward. This is the reason why I preferred that, before one starts on investing, it is good to have a basic grasp of economics.

 

 

1 – The Bedokian Portfolio (2^nd ed), Chapter 11.