Meet the Augmented Unemployment Rate

Did the Fed's rate-hike announcement last week fundamentally change the way the Street examines the monthly employment report?

To many, it appears that when the November edition of the most important economic indicator is released Friday, Dec. 3, at 8:30 a.m. EST, bond trading desks will immediately send their economists scurrying after a component that traders have never cared that much about before.

Ladies and gentlemen, meet The Augmented Unemployment Rate.

No, this is not a brand new concept. Fed Chairman Alan Greenspan has been musing about it in his public pronouncements since at least February. In his Humphrey-Hawkins congressional testimony on Feb. 23, he said this:

The number of people willing to work can be usefully defined as the unemployed component of the labor force plus those not actively seeking work, and thus not counted in the labor force, but who nonetheless say they would like a job if they could get one. This pool of potential workers aged 16 to 64 currently numbers about 10 million, or just 5 3/4% of that group's population -- the lowest such percentage on record, which begins in 1970, and 2.5 percentage points below its average over that period. The rapid increase in aggregate demand has generated growth of employment in excess of growth in population, causing the number of potential workers to fall since the mid-1990s at a rate of a bit under 1 million annually. We cannot judge with precision how much further this level can decline without sparking ever-greater upward pressures on wages and prices. But, should labor market conditions continue to tighten, there has to be some point at which the rise in nominal wages will start increasingly outpacing the gains in labor productivity, and prices inevitably will begin to accelerate.

This calls for a bit of translation. The Labor Department, when it compiles the monthly employment report, calculates the unemployment rate by dividing the number of unemployed by the workforce, which consists of the employed and the unemployed. That measure hit a 29-year low of 4.1% in October.

Greenspan is saying that a better measure of the tightness of the labor market also takes into account jobless people who aren't counted among the unemployed because they haven't searched for work lately, but who would take a job if offered one.

There are a variety of ways of taking that measure. In his February remarks, Greenspan refined his thoughts by excluding workers over 64 years old. But the July Humphrey-Hawkins report (not the accompanying testimony), included a statistic it called the augmented unemployment rate for the first time, defining it simply as "the number of unemployed plus those who are not in the labor force and want a job, divided by the civilian labor force plus those who are not in the labor force and want a job." As the chart shows, this rate dropped to 6.81% in October.

The Augmented Unemployment Rate The number of unemployed plus job-seekers not in the labor force, divided by the labor force plus the job-seekers

Source: Labor Department

Greenspan repeated his February language verbatim at a Chicago Fed conference in May. And last month, he told an industry group:

In addition, over the past two years, the pool of people seeking jobs -- the sum of the officially unemployed plus those not in the labor force but wanting to work -- has declined from 11.2 million to 9.6 million. The number of workers drawn into employment in excess of the normal growth in the workforce has been running at the equivalent of roughly a half of a percentage point of annual GDP growth. This gap must also eventually be closed if inflationary imbalances are to continue to be contained.

But last Tuesday's statement by the Fed's monetary policy committee announcing the hike in the fed funds rate to 5.5% from 5.25% enshrined the concept as never before, presenting it as the final determinant of future decisions on interest rates.

"Despite tentative evidence of a slowing in certain interest-rate sectors of the economy and of accelerating productivity," the Federal Open Market Committee said, "the expansion of activity continues in excess of the economy's growth potential. As a consequence, the pool of available workers willing to take jobs has been drawn down further in recent months, a trend that must eventually be contained if inflationary imbalances are to remain in check and economic expansion continue."

(The FOMC had made the same point in its statement on Oct. 5, when rates were left unchanged, but less forcefully.)

The wisdom of the approach is questionable. Last week, High Frequency Economics' chief U.S. economist Ian Shepherdson pointed out that the survey that gathers the numbers that go into the augmented unemployment rate "regularly produces bizarre swings in many of its components."

But that's not the point. The approach is being taken. So, when the November jobs report is released, will bond traders want to know the augmented unemployment rate at the same instant they know the report's other key components (the number of new nonfarm jobs created, the regular unemployment rate, and the increase in average hourly earnings)? If not, should they?

Absolutely, Morgan Stanley Dean Witter chief money-market economist Bill Sullivan says. "This is a new economic indicator." Last Tuesday's statement "is a sanctification of [the augmented unemployment rate] as a new and paramount data series for the market to follow."

"People have finally awakened to the importance of this number and it's going to be big," agrees Daiwa Securities chief economist Michael Moran. "I don't know if it's going to be more important than the payroll number, but it's certainly going to get more attention than it has in the past."

And Tom Connor, head government bond trader at J.P. Morgan, says that because the last two FOMC statements have made pointed mention of the measure, "the market's going to put unusual focus on it."

There's a problem: All of the numbers that go into the augmented unemployment rate are in the jobs report, but the Labor Department doesn't calculate it (at least it hasn't up to this point). So will the market know the rate in the same instant it knows all the other major components of the report? That depends on whether the Washington journalists sequestered with it opt to do the calculation and send out headlines. Given that there's not yet an agreed-upon way to calculate the rate (Subtract the over-64 set or not? Mix seasonally adjusted numbers with not-seasonally adjusted ones or not, since the number of people not in the labor force who want a job isn't seasonally adjusted?), it's doubtful there will be headlines.

Still, a lack of headlines doesn't mean there won't be a market reaction. It may simply be delayed until economists crunch the numbers -- however they see fit.