Thursday, June 03, 2010

Macro Research

Nonfarm payrolls preview: May brings employment to half a million Americans

Tomorrow’s US labour market report is expected to show that the economy added 560,000 jobs in May,
160,000 of which are private sector jobs. In other words, 400,000 of the new jobs can be attributed to
the public sector – mainly temporary Census hiring. May’s impressive contribution to overall employment
will push the unemployment rate down to 9.8% following last month’s surprising 9.9% reading.

US Labour Market Saxo Bank Consensus

Low Median High
Change in Nonfarm Payrolls (1000s) 560 220 515 750
Change in Private Nonfarm Payrolls (1000s) 160 30 178 257
Unemployment Rate 9.8% 9.6% 9.8% 10.0%

Half a million initial jobless claims equals half a million new payrolls?

Last month we learned that the economy added 231,000 private sector jobs according to the Bureau of
Labor Statistics (BLS), but added only 32,000 if you look at ADP’s payroll report (since revised to 65,000).
At the same time initial claims averaged 459,600. Why are so many people receiving benefits when the
economy supposedly added more than two hundred thousand jobs in April?

Jobless claims data is a solid tool for examining labour market health, but there are limits to its
usefulness. A rule of thumb states that when claims drop below 400,000 the monthly change in nonfarm
payrolls will turn positive. It must be emphasised that this is nothing but a rule of thumb as initial jobless
claims data does not capture changes to employment directly.

Initial jobless claims are so far averaging 459,000 for May and claims for the week in which the BLS
conducts the nonfarm payrolls survey were 474,000! Put differently, two-and-a-half years after the
recession officially began almost half a million Americans must still walk with heavy footsteps to a state
agency and apply for claims. But that is only for first-week claims. We have 4.6 million unemployed
workers who have been receiving aid for two to 26 weeks. Add all the emergency benefits and you can
safely add another five million to the statistics.
The stagnation in initial jobless claims over the last six months seems puzzling when we consider the
improvement in nonfarm payrolls, but it is in fact explainable.

The problem is that the behaviour of unemployed workers has shifted during this recovery. There are still
a great many workers being laid off across the USA and they will – quite reasonably, especially given the
severity of the labour market situation – apply for jobless benefits. Companies are still cutting costs,
which means downsizing staff. However, at the same time the bleeding of people exiting the labour
force has stopped after the previous year’s mass-exits. In fact, people are again entering the labour
market. Not all of this is necessarily due to better job prospects yet, but because of the distress in
households’ finances. The longevity of the last recession and current recovery – a recovery in which
wages are still stagnant – means that people are more willing to stay as unemployed to collect some sort
of income. Instead of deciding to drop out of the labour force and rely on savings - however meagre
those must be given the savings rate in the last decade and negative home equity – people stay in the
labour force now and collect claims. And we must not forget that the continually extended emergency
jobless claims, which now allows for roughly two years of jobless benefits, may be the only source of
income for some families.

The high jobless claims numbers are therefore not irreconcilable with job growth as measured by
nonfarm payrolls (or household survey employment numbers), but simply demonstrate the harshness of
the Great Recession. The economy is once again generating new jobs, but at the same time many people
continue to rely on jobless benefits as their only means of getting by, which can explain the combination
of very high claims and solid job growth. Furthermore, it shows the distress in the daily lives of ordinary
Americans suffering from the protracted cost cutting done by US companies (which in itself is a healthy
thing).

What difference does a few hundred thousand make?

On the face of it half a million new jobs do not resonate very well with the other labour market
indicators, which are all decidedly less upbeat about the situation for the average working Joe. Even if
we strip out the decennial census workers and look at private jobs, the divergence between our
expectation of 160,000 and other available indicators is noticeable.

ADP Employment out earlier today showed an increase of 55,000 nonfarm payrolls in May – below
consensus of 70,000 – following a revised addition of 65,000 in April (32,000 prior). Meanwhile, initial
jobless claims remain hopelessly elevated around 460,000 and if you add a zero you get continuing
jobless claims. But as we have seen, claims are unusually sticky due to the adverse situation facing
American households.

The ADP report is for private payrolls only, so it will obviously diverge from total nonfarm payrolls as
measured by the BLS when the government conducts temporary hiring on a large scale. But why did the
market expect 70,000 new private payrolls in the ADP report, but at the same time 178,000 for BLS’s
private nonfarm payrolls estimate tomorrow? Especially considering the 0.96 correlation! And why was
the divergence between ADP’s and BLS’s private nonfarm payrolls estimates a massive 166,000 private
payrolls in April (199,000 before today’s ADP revision)?

It is important to recognise the difference between the various employment reports. ADP uses data from
about 360,000 clients covering 22 million private payrolls; the Establishment survey includes 140,000
companies and government agencies and the resulting number is nonfarm payrolls; and the Household
survey covers 115-120,000 persons from 50,000 households. The latter survey gives us the unemployment
rate, but also provides its own estimate of changes to employment. Contrary to the other two the
Household survey does not measure the number of jobs per person. The ADP and the Establishment
survey will both count a person having two jobs twice while the Household Survey will not; it merely asks
whether the individual is employed or not.
The Household survey captures new business starts more accurately – and thus generally turns ahead of
the Establishment survey. This is where the (in-)famous birth/death model comes into play as the
Establishment survey tries to capture small business formation and self-employed. On the other hand,
the smaller sample size used makes the Household survey more volatile month to month.

The answer to the question above is found in the various methodologies already mentioned, unsatisfying
as it may be for some. ADP uses its client base and does not adjust for new business formation that
cannot be found directly in its data. It does, however, adjust its estimate based on comparisons with the
BLS series. New businesses are not as likely to use ADP’s products (payroll processing) to the extent that
mature companies do. This will result in a failure to pick up new business formation. However, it does as
a matter of business have a large client base among small and medium-sized companies and these
companies led today’s 55,000 increase in private payrolls by contributing 52,000; thus the ADP report
does provide unique insight into the labour market due to its proprietary data. Also bear in mind that the
various estimates come with a margin of error (90-percent level of confidence), which in the case of the
BLS nonfarm payroll estimate is around 100,000. And that is when the BLS has received data from all the
surveyed companies, meaning after revisions. So quite often the estimates are insignificant from each
other though the media will trumpet them as wildly different.

The Household survey, erratic in the short-term as it may be, does not suffer from the computations
needed by the BLS’s nonfarm payrolls estimate to capture new businesses. And if we smooth out short-
term noise it does indeed point to fairly solid job growth. This is also confirmed by temporary help
services, which is often used as a gauge of future job growth.
Demand for Census workers to peak in May

Peak hiring for the decennial census is typically in May, but there is great volatility across Censuses. In
May of 1990 hiring peaked at 182,000 while the 2000 Census basically doubled that amount to 348,000.
This year’s Census has so far matched the 1990 Census quite closely, but there aren’t enough
observations to credibly make any type of inference. Indeed, available numbers for May point towards a
much higher number in the 400-500 region – and that’s for temp workers alone. We thus use 400,000 as
our addition from temporary decennial workers, but advise against focusing on the total nonfarm payrolls
number. Look at private payrolls instead.

Unemployment rate to edge lower again

The unemployment rate jumped 0.2%-points to 9.9% in April and illustrates just how powerful the labour
force participation rate can be when we talk of the rate of unemployment. Despite negative nonfarm
payroll numbers in the second half of 2009 the unemployment rate first stagnated and then fell as people
skipped the unemployment queue and raced for the exit; the exit from the labour force, that is. Now the
situation is reversed –partly due to the severity of the situation for households as we have seen – and
thus employment gains will not lower the unemployment rate “one-to-one”.

Tomorrow’s massive gain in employment should push the unemployment rate down to 9.7% again, but we
expect the influx of people to the labour market to counteract this somewhat and consequently expect
the rate of unemployment to land on 9.8%. Note that the unemployment rate is also influenced by the
number of temporary Census workers, so the high and low forecasts from Bloomberg’s survey (shown at
the top) are all reasonable.

Private job growth

Flashing headlines exclaiming that the economy added half a million jobs in May are quite likely
following the release of the report tomorrow, but pay no attention to that. This is still a weak recovery
by most standards emphasized by the stagnating wages. Employers are still in complete control, but have
slowly begun hiring again as is also evidenced by the ISM indices. The employment component of the ISM
Manufacturing index is at a post-recession high of 59.8 while the equivalent in the service sector just
crawled above 50 for the first time in today’s report (50.4). Private jobs are increasing now, but don’t be
blinded by the headlines tomorrow. Look at the private payrolls number. While this too may diverge
quite a lot from the ADP equivalent, it is at least cleared from the Census distortion.
A final word of caution is that the ADP report, the Establishment survey, and the Household survey are
all estimates of the actual employment situation (based on State unemployment insurance tax fillings
published many months later). The BLS estimate is just one of many, but clearly the market favours it.
However, if your mission is an accurate description of the reality facing working Americans then analyse
them all. Let’s not forget that it is only five months since the BLS in their annual revision changed the
number of total payrolls by more than a million – though by the time the next annual revision comes
around in January 2011 such changes to payrolls are not just old news, it’s ancient.

We expect private nonfarm payrolls to come out in the region of 160,000 as the jobs engine continues to
pick up steam. Initial Jobless claims and ADP, however, suggest a slight deterioration relative to the
impressive April number of 231,000.
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