The Effects of Unemployment on Interest Rates and Bonds

Causes of structural unemployment

A new view of unemployment could provide insights that will allow you to ideas about bond and stock investing before the crowd finds out about these insights. There was an excellent article by Gavyn Davies in Financial Times on 5-5-2011 about structural unemployment. The rate of unemployment is much worse in proportion to the drop in GDP than in normal cycles or in other countries.

I really appreciated his insight about the 2% excess unemployment (the excess is the amount exceeding that forecasted by Okun’s law) shown on the graph. One explanation is that a recession caused by a financial crisis is usually deeper than a traditional inventory cycle recession. My hypothesis is that in the U.S. there has been no increase in private sector GDP since 1998 and during the past decade there was an excess amount of employment and personal earned income in the mortgage, real estate, and construction industry which could have temporarily over-employed 2-3% of the labor force who engaged in unneeded real estate bubble activities.

Further, some of those jobs were artificially high paying due to the real estate bubble, so when the bubble burst the job losers were unwilling to accept lower paying jobs in a new career, preferring instead to stay home and sulk in hopes of someday recapturing their lost income. In a normal inventory cycle recession people think they can wait a year for the economy to heal itself and then go back to their old job. However, this time the unemployed former beneficiaries of the burst bubble need to realize that a fundamental structural shift has occurred and learn to adapt to it.

Today’s monthly unemployment report

Today the monthly unemployment report was issued showing 244,000 new jobs. However the economy needs to produced 300,000 a month consistently for several years to get out of the situation of excess unemployment and this has not been done since the 1990’s, which was an exceptionally prosperous decade.

The employment to population ratio dropped by 0.1% and is close to 28 year lows. Headline unemployment and the broad U-6 measure both increased by 0.2%. The number of unemployed increased by 205,000 to 13,800,000, an increase of 1.5%. Household employment fell by 190,000. Despite the fact it has been two years since the bottom of the recession, only 20% of the lost jobs have been recovered. Usually two years after the bottom the job market has fully recovered.

Effect of this on interest rates and bond prices

This is why interest rates should be at today’s low levels and why there is no significant inflation. Because the market does not understand this that means bonds are mispriced – when the market becomes efficent and understands this, then bond prices will rise.

About the author

Don Martin, CFP®

2 Comments

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  • We know that reduced interest rates arguments employment rates,but why is it that in less developed countries even when interest rate drops with an increased consumption rate unemployment still seems to climb higher?

  • We know that reduced interest rates arguments employment rates,but why is it that in less developed countries even when interest rate drops with an increased consumption rate unemployment still seems to climb higher?

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