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Unemployment rate forecast: Will the job market suffer from monetary tightening?

By Ryan Hogg

Edited by Jekaterina Drozdovica

16:14, 9 January 2023

Unemployment rate graph is increasing. Inscription unemployment rate under a magnifying glass.
What are the latest unemployment rate forecasts as interest rates begin to bite? Photo: iQoncept / Shutterstock

Unemployment has remained low in a golden age for the labour market, with the great resignation bringing newfound liberty to employees.

But headwinds are approaching. Several central banks have hiked interest rates, and demand is starting to seep from the economy. While the labour market has remained stable, few agree this will be a constant.

As unemployment rate forecasts trend in a worrying direction, it's important to know how joblessness will filter through to markets and the wider economy.

How is unemployment measured?

Unemployment is driven by various factors, all of which impact the supply and demand of labour within an economy.

Employment and unemployment are typically measured as a percentage of the labour force, calculated as a proportion of those either working or actively seeking work and of a working age, which in the OECD averages about 78% of 25-64 year-olds. The proportion of that group not in work but actively seeking employment make up the unemployment rate of a labour force.

The rate of unemployment is a good proxy for measuring efficiency in an economy, and how close it is to operating at capacity. It can also signal changes in other indicators like wages, household income and house prices.

Academics and policymakers tend to agree the labour market can reach a level of full employment, which coincides with natural unemployment. This is a point where the labour force is operating at full potential, with some spare capacity to reflect unemployment occurring from structural forces in the economy. 

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Different types of unemployment explained

There are four key types of unemployment. It's important to distinguish between them to understand the overall state of the economy.

Frictional unemployment

Frictional unemployment is a micro form of unemployment. It refers to the period when a worker moves between two jobs. This is rarely an endemic issue, and still occurs when the economy is at full employment.

Cyclical unemployment

Cyclical unemployment occurs as a result of an economic downturn, like a recession, and relates to a contraction in the business cycle. This can affect industries vulnerable to falls in demand and discretionary spending, like hospitality and retail, or industries dependent on advertising revenue, like the tech sector.

A historical analysis of the US unemployment rate, for example, shows a highly cyclical trend that coincides with inflation, interest rates and economic growth. Unemployment is a lagging indicator – the labour market can temporarily appear healthy despite other major economic indicators showing signs of recession.

Structural unemployment 

Structural unemployment refers to an economic shift. It’s often driven by a technological change that makes jobs obsolete. The structural unemployment that follows relates to a skills gap in the economy.

Institutional unemployment occurs thanks to government and institutional factors and incentives, as Indeed reports. This could include high legal minimum wages, strong social security programs or discriminatory hiring practices.

Key unemployment trends 

Despite economies across the west sending out increasingly gloomy signals, the story of the labour market remains one of extreme tightness. 

The onset of the Covid-19 pandemic heralded a major shift in working habits, forcing down participation rates to historic lows as quitting soared. Meanwhile, macroeconomic pressures are increasingly coming into view as rising interest rates and a falling stock market, alongside still-high inflation, put the brakes on a hot economy.

Great resignation continues to keep labour markets tight

Millions of US workers quit their jobs in 2020 and 2021 during the ”Great Resignation”, a period of mass resignations where power shifted from employers to employees.

“The pace of resignations seems to have risen more quickly than one would have expected from labour market tightening alone,” according to a US Bureau of Labor Statistics (BLS) report, with quit rates spiking to 3% of total employment in mid-2020, having spent most of the prior decade at or below 2%.   

It’s a surprising trend given the context of wider macroeconomic pressures during the Сovid-19 era, with fiscal stimulus and increased worker flexibility.

“Many were buoyed by large furlough payments or self-employment and business grants, softening the blows of work downturns and affording them time to consider their next career steps,” recruitment group Michael Page wrote of the UK quitting trend. 

“With lockdowns forcing a rise in remote and flexible working, many chose to leave roles that were normally office-based.”

Participation rates in economies accordingly fell and have remained below pre-Covid highs. In the US, a falling trend of participation that had been occurring since the last recession was exacerbated, dipping to around 60% in 2020. While it has rebounded, the December 2022 participation rate of 62.3% is still notably below pre-Covid levels.

US labour force participation rate, 2018 - 2023

This means that businesses remain squeezed for labour, keeping unemployment rates down. 

The unemployment rate for the US was 3.5% in December 2022, the same level as before Covid, as the country’s labour market added 223,000 new jobs

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It could be a warning for the future, with declining birth rates and an ageing population. There is some feeling that the labour market will remain tight for the foreseeable future. While low birth rates boost participation among female workers, analysis by Pew suggested the trend could shrink the labour force over time, pushing up unemployment rate expectations. 

Inflation remains elevated

Inflation and unemployment have an inverse relationship. When unemployment is low, inflation is observed to increase as a reflection of a tight economy where demand and spending are rising. Inflation falls as unemployment rises and demand contracts, easing price pressures. 

This is observed in the Phillips curve, showing inflation rising as unemployment falls.

US inflation rate versus US unemployment rate, 2018 - 2023

During Covid-19, this relationship broke down as governments propped up employment with fiscal stimulus while demand remained low, keeping prices down. 

Inflation can have a direct impact on the predicted unemployment rate. Higher costs can affect margins, while rising prices can be deflationary by hurting demand. Both can bring about a rise in the unemployment rate through forced redundancies.  

But the real danger to the labour market comes from policymakers’ response to high inflation. Indeed, many experts, including Larry Summers in a recent Bloomberg interview,  have argued unemployment will need to rise to bring prices down. 

How do countries fight unemployment?

There are various fiscal and monetary levers policymakers can pull to tackle unemployment. 

Governments can introduce tax cuts and other support to incentivise companies to increase hiring, or raise public spending to increase the demand for workers on infrastructure projects or in healthcare and education. These would be described as countercyclical policies.

In tandem, if unemployment is rising within a deflationary environment like a recession, where prices fall below the traditional 2% target, central banks can help alleviate joblessness by cutting interest rates. Lower interest rates make borrowing cheaper and saving less profitable, stimulating demand in an economy.

This is typically not possible in a high inflation environment, as it would break a central bank’s main objective of low and stable prices. 

Ultimately though, countries are typically at the whim of wider economic movements, and can struggle to seriously influence unemployment during a downturn in the economic cycle without damaging other areas of their economy.

US unemployment rate forecast for 2023 and beyond

The US has been a good representative for the behaviour of the Western jobs market. After hitting a peak of 14.7% in April 2020, a month after lockdowns hit, the US labour market burst back into rude health as restrictions eased and fiscal stimulus seeped through to the economy.

Unemployment has been hovering around pre-Covid rates of 3.5% since March 2022 and is enjoying its lowest sustained rate since the late 1960s.

But unemployment rate forecasts from most sources presume joblessness will rise this year, trending alongside other indicators further along the business cycle dip.

In a January 2023 note, ING analyst James Knightley pointed out leading indicators of low consumer confidence and slowing manufacturing orders, noting that the labour market is typically the last indicator to turn:

“This suggests that businesses will increasingly adopt a defensive stance, which implies a greater focus on costs, including labour. So far the job loss announcements have been concentrated in the tech sector and, more under the radar, the temporary help sector, but we expect that to change over the next twelve months.”

This is reinforced by a hawkish stance of the US Federal Reserve (Fed), which hiked its base interest rate by 400 basis points over 2022, a move that could affect the labour market. 

According to a projection by the OECD, the joblessness rate could rise to 4.71% in the US by the end of 2024.

A forecast by Trading Economics, as of 9 January, suggested that unemployment could hit 4.6% in 2024, before falling to 4.4% in 2025.

Final thoughts 

Note that analysts’ unemployment rate predictions can be wrong and shouldn’t be used as a substitute for your own research. Always conduct your own due diligence before trading, looking at the latest news, technical and fundamental analysis, and a wide range of analysts’ commentary.

Remember that past performance does not guarantee future returns. And never trade more money than you can afford to lose.

FAQs

How is the unemployment rate calculated?

The unemployment rate is taken as a percentage of the labour force that are is working but actively seeking employment.

Is unemployment rising?

Unemployment in the US has hovered around 3.5% since March 2022, and hasn’t shown any suggestion that it will rise soon.

Why is the unemployment rate important?

The unemployment rate is a sign of inefficiency and economic contraction in an economy, as it demonstrates the share of the population that can’t get work despite actively seeking it. 

How do unemployment rates affect the economy?

Higher unemployment leads to less output in the economy, and less income for its citizens, hurting aggregate demand. It also amounts to less tax income for governments and more spending on social security benefits, negatively affecting budgets.  

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