Every quarter, my team and I produce the Guide to the Markets, an 85-page chart pack featuring more than 150 charts. Each one tells a story, so it is always tough to choose a favourite, but as we get into the later part of the US cycle and asset allocation calls become increasingly important, I’m firmly focused on the ones that can tell us what to expect.
Of all the macro indicators, the unemployment rate is undoubtedly one ofthe most important. Calculated as the number of people of working age who are not able to get a job but would like to be in full-time employment, as a percentage of the labour force, this has historically been oneof the most important indicators of thestate of the economy. That is because the labour market is intrinsically tied to the business cycle.
In the early stages of a cycle – the expansionary phase – growth is relatively fast, interest rates are low and businesses add to their workforce and increase production. The unemployment rate decreases and inflationary pressures begin to build.
At the peak of the cycle, production output is at its maximum and unemployment is low as inflationary pressures lead central banks to increase interest rates, which eventually reduces company profits. This causes unemployment to rise and production output to decrease, creating a recession: two or more quarters of negative GDP growth.
We investigated how the UK and US unemployment rates have interacted in the past. The chart shows that the US unemployment rate reaches its lowest point before a recession occurs in the US economy, and the same for the UK.
In the past five US recessions, the UK has experienced a recession four out of those five times. Conversely, in the past four UK recessions, the US has seen recessions three out of these four times, so the economic cycles of the UK and the US have been closely linked in the past. Given the increasingly globalised nature of the world economy, we would expect this relationship to be stronger than ever. But recessions have not always been shared, as they can be triggered by more local market effects, like the shallow 2001 recession in the US caused by the dotcom bubble bursting.
So does one economy lead the other whenit comes to timings? In each of the pastthree “shared” recessions in the past 40 years, the US has entered recession before the UK. But once the US had entered recession, the UK was never more than seven months behind.
Both economies can see unemployment stay at its minimum level for a given cycle, for many months and years before entering a recession. For example, in the 1980 recession, the US entered recession eight months after unemployment reached a low; in contrast, this figure was double in the UK for the corresponding recession.
In the most extreme case, the UK 2008 recession, which was caused by the global financial crisis, was four years after reaching the minimum unemployment level for the cycle that a recession was observed. Even then, the length of time before reaching a recession can range from six months to several years.
Also, the minimum level of unemployment before a recession is not always the same,as a recession might be triggered by a specific market event before full employment is reached. The 2008 recession happened when unemployment in the US was around 4.5 per cent, in contrast to the 3.8 per cent level reached before the prior recession. Another reason may be that the labour market has structurally changed over time, causing the true full employment level to move.
This minimum level also varies between economies, again because of structural differences in the labour markets.
Nandini Ramakrishnan is a global market strategist at JPMorgan Asset Management
