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Rare air

| October 12, 2018

This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.

The U.S. unemployment rate sank in September to 3.7%.  It is impressive enough to note that this is the lowest level of joblessness in nearly 50 years, but the reality is even more dramatic.  In peacetime, the unemployment rate has not been lower than the current setting in almost 100 years.

A new cycle low

In the September employment report, the unemployment rate surprisingly posted a dramatic fall from 3.9% to 3.7%.  That reading was marginally lower than the May 2018 and April 2000 lows of 3.8%.  The last time that the unemployment rate was lower was the late 1960s (Exhibit 1).

Exhibit 1: Unemployment rate

Source: BLS.

Life during wartime

As Exhibit 1 shows, the only times that the unemployment rate has been lower than the current level over the past 70 years (the entire history of the series) were in the early 1950s and in the late 1960s.  U.S. history aficionados will quickly note that each of those episodes were periods of war.  In the late 1960s,

the U.S. had deployed over half a million troops to Vietnam (and close to three-quarters of a million in total in East Asia).  In a hypothetical where there was no war, if even 100,000 of those men were unemployed (or if their employment displaced that many others from jobs), the jobless rate would have been above 4% instead of in the mid-3%’s.  In any case, that era is well known in economic history as the Guns and Butter period, when the federal government spent heavily both domestically and on the military, which, with the help of persistently easy monetary policy, helped to generate a sharp acceleration in inflation.  The CPI accelerated from below 3% through most of 1967 to 6% by the end of 1969.

Going back further, the unemployment rate dropped below 3% in the early 1950s.  Again, this coincided with the height of the Korean War, when the U.S. sent over 300,000 troops to Korea and over half a million to all of East Asia.  To put that into perspective, the civilian labor force in the early 1950s was less than 20 million, so that the 300,000 potential workers taken out of the job market represented at that time close to 1.5% of the civilian labor force (we cannot say much about inflation pressures in that period because, as it had during World War Two, the federal government imposed wartime price controls in support of the war effort).

Wayback Machine

While the monthly unemployment series as we know it only began in 1948, there are other data going even further back in the nation’s history.  Annual readings are available going back to 1900 in the Census Bureau’s compendium of historical statistics (Exhibit 2).

Exhibit 2: Unemployment rate 1900 to 1947

Source: Census Bureau

Not surprisingly, the unemployment rate was lowest during the two World Wars (1914-1918 and 1941-1945).  The last peacetime period when the unemployment rate was as low as it is today is the mid-to-late 1920s.  While the economy was so different nearly 100 years ago that it is difficult to even begin to make comparisons, to tie the current environment to the 1920s is hardly a reassuring thought given how the “Roaring 20s” ultimately ended.

Where to next?

Notwithstanding the rhetoric over the past week from President Trump, the most striking aspect of the current episode is that the unemployment rate has already dropped to a nearly 50-year low while Fed policy remains well to the accommodative side of neutral.  The FOMC estimates that the long-run neutral setting for the funds rate is about 3%, a level that “gradual” rate hikes will not reach before mid-2019 (at the earliest).  In light of the lags associated with monetary policy, it is quite possible that, if the economy is not hit by any major shocks, the unemployment rate could continue to decline for another 18 months or more.  Indeed, I would not be surprised to see the unemployment rate fall into the low 3%’s by 2020.  Surveys and anecdotes already suggest that the labor market is extremely tight, with job openings approaching 7 million (a million higher than the ranks of the unemployed), firms complaining of a lack of qualified job candidates, and help wanted signs ubiquitous.  Labor market conditions could get really interesting over the next year or two.

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