Thursday, February 13, 2014

Unemployment and Interest Rates

Unemployment claims seem to be reaching a trough level.  Here is a graph from Fred:
FRED Graph
Blue: Initial Unemployment Claims, scaled to Labor Force
Purple: Insured Unemployment Rate
Green: Unemployment Rate (scaled by 1/2)
Red: Slope of Yield Curve (5 Year - Fed Funds) - right scale

I thought there were several interesting relationships here.
1) The difference between the Insured Unemployment Rate and the level of Initial Claims is a kind of proxy for duration of unemployment in the regular UI program.  This relationship isn't affected by the unusual long-duration behavior we have seen this cycle.  Durations among this group appear to be entering the mature phase of the recovery.

2) Unemployment is very high compared to insured unemployment.  This gap will mostly close over the next 6 to 12 months, giving the real economy a boost.  (speculative)

3) The flattening of the trend in unemployment claims has recently (by recently, I mean the last 25 years) been associated with a flattening yield curve (a drop in the red line).  Most of this flattening usually would mostly be the result of rising short term rates.  But, the current rate environment is difficult to compare to other cycles.

Rates might be rising earlier than many suspect, with the Fed adjusting interest on excess reserves upward as a secondary tool along with selling treasuries.


  1. What counts as a "short term rate" with the front end pegged at zero for the foreseeable future?

    1. That's a good question. Forward rates imply a 5yr-FedFunds spread topping out at about 2% in 2015, when the Fed is expected to start raising rates. The spread would decline after that, hitting 1% in 2018.

      This pattern is not that different from the pattern after the 2000-2002 recession, but that recession saw an unusually extended period of time with depressed short term rates. In the past, unemployment rates under 6% haven't been associated with extended periods of time with 5 year yield curve spreads above 1.

      The steeper yield curve might be related to the low inflation environment, where forward rate risks are skewed more toward inflation risks. In the 1970's and early 80's, when the slope tended to be lower, high inflation was embedded into the short term rates.

      The future yield curve slopes seem to be at the high end of what we might predict from past experience. So, I think the speculative position would want to be neutral about the forward yield slope, or somewhat positioned for it to flatten more quickly than the forward curve is predicting. That flattening could happen either because a too-hawkish Fed leads to lower long rates in a pessimistic context. Or, it could come from a quickly recovering economy that pushes short term rates up more quickly. Either of these outcomes are possible, but they would both flatten the future yield curve.

      There is no recent historical precedent for a yield curve that is steeper or more persistent than what is already priced into the forward rates.