MacroScope

The U.S. jobless rate, currently at 7.7 percent, remains elevated by historical standards. But it has fallen sharply from a peak of 10 percent in October 2009. However, that decline could soon grind to a halt, according to a recent paper from the San Francisco Federal Reserve.

Its authors argue that, because the slow but steady decline in the jobless rate has been in part due to slippage in the labor participation rate that is more a product of the business cycle than long-run demographic trends, as the Bureau of Labor Statistics presumes.

In January, the U.S. Bureau of Labor Statistics significantly reduced its projections for medium-term labor force participation. The revision implies that recent participation declines have largely been due to long-term trends rather than business-cycle effects. However, as the economy recovers, some discouraged workers may return to the labor force, boosting participation beyond the Bureau’s forecast. Given current job creation rates, if workers who want a job but are not actively looking join the labor force, the unemployment rate could stop falling in the short term.

The rate of labor force participation has slid to its lowest level in 30 years.   

This means that, just as years of weak consumer spending are expected to produce some amount of pent-up demand, so too could a prolonged period of high unemployment and underemployment unleash a new burst of entrants into the job market. That would ultimately be a positive sign – but the data may not look pretty.

As traders and economists hash over the sharp and unexpected drop in the U.S.jobless rate to 7.8 percent, they might do well to review some key data points that offered early hints that at least some households were seeing improvement in the labor market. Wall Street analysts in a Reuters poll had forecast a rise in the unemployment rate to 8.2 percent.

Even as big companies were laying off more workers or at least holding back on hiring, The Conference Board’s consumer confidence data showed workers felt more encouraged about finding jobs. The Thomson Reuters/University of Michigan survey depicted a late summer upturn in consumer mood even as gasoline prices remained high. The latest ADP report, with all its perceived flaws, indicated a consistent, moderate acceleration in hiring among small- and mid-sized companies since late spring even though big firms seemed reluctant to expand their payrolls.

The graph below shows confidence improving as job prospects brighten.

The “big wildcard” in making July payroll projections is the size of the swing in public school teachers and other school workers.

Because of the size of teacher layoffs and the effect of the July 4th holiday on the data, the July seasonal adjustment factor can vary significantly from one year to the next, and the variation can be extreme, says Ward McCarthy, managing director and chief financial economist at Jefferies & Co in New York.

Many public school teachers, in addition to some other public school employees, are hired on a ten-month calendar that runs from September through June, large-scale layoffs occurring in July and large-scale hiring occurring in September.