Economic Reality: Unemployment and the Federal Reserve Balance Sheet

In early July, I rolled out an “economic reality” index to provide a sober summary of the economic trials and tribulations facing millions of Americans even as those of us with trades and investments in the stock market enjoy the largesse of monetary and fiscal stimulus. I am now putting the chart comparing continuing claims on unemployment benefits and the labor force participation rate on a page where it refreshes with new data. I added a chart of the Federal Reserve’s balance sheet for additional context.

Continuing Claims versus the Labor Force Participation Rate

Continuing claims provides a count of people receiving on-going unemployment benefits. These claims represent a baseline measure of the health of employment in the U.S. Initial claims come from people filing for unemployment for the first time. Those initial claims add to the continuing claims. Continuing claims shrink once people find jobs or stop looking for work and drop out of the labor force.

The labor force participation rate measures the percentage of the potential workforce that is actively seeking work. Given America’s aging population, changes in the labor force participation rate can be more important than the absolute levels. In other words, acceleration or deceleration in the on-going secular trend signifies potentially important economic events. As of the summer of 2020, the coronavirus pandemic is the driver of economic stresses.

Source: U.S. Bureau of Labor Statistics, Labor Force Participation Rate [CIVPART], retrieved from FRED, Federal Reserve Bank of St. Louis; and U.S. Employment and Training Administration, Continued Claims (Insured Unemployment) [CCSA], retrieved from FRED, Federal Reserve Bank of St. Louis

The stock market treats unemployment as a lagging indicator of the health of the economy. The trend in initial employment claims tends to provide more timely information, and the stock market tries to time the peak in initial claims. In “Stock Market Bottoms Ahead of the Worst Jobs News In A Crisis” I showed how the S&P 500 (SPY) achieved major bottoms just ahead of or in conjunction with a peak in initial claims during the last two major economic upheavals.

Source: U.S. Employment and Training Administration, Initial Claims [ICSA], retrieved from FRED, Federal Reserve Bank of St. Louis

Federal Reserve’s Balance Sheet

The Federal Reserve’s balance sheet is a measure of the support the U.S. central bank is providing to economy. The bigger the balance sheet, the more liquidity in financial markets. Changes in the balance sheet directly contribute to changes in asset prices, especially in the stock market. The balance sheet reached historic levels in the wake of the 2008-2009 financial crisis. That surge now looks like child’s play compared to sudden and sharp surge in the size of the balance sheet in response to the economic shutdown from the COVID-19 pandemic.

Source: Board of Governors of the Federal Reserve System (US), Assets: Total Assets: Total Assets (Less Eliminations from Consolidation): Wednesday Level [WALCL], retrieved from FRED, Federal Reserve Bank of St. Louis

The Fed has been unable to pull back its support in any meaningful way as the economy and financial markets have proven themselves nearly completely dependent upon and addicted to monetary stimulus. The ramp in 2013 came in the wake of a late 2012 stock market sell-off. At the time, the stock market panicked about a toxic combination of expiring tax cuts and cuts in government spending called the “Fiscal Cliff.”

Finally from March, 2018 to September, 2019 the Federal Reserve made its first significant drawdown on the balance sheet. That monetary tightening was at least partially blamed for driving a sharp stock market sell-off in late 2018. The Federal Reserve was forced to start growing the balance sheet again as it moved back into monetary easing. The Fed called it a “mid-cycle” adjustment.

Early Signals for the Economy and the Stock Market

Unemployment and Federal Reserve easing and tightening form the core of economic reality for working Americans, diligent investors, and frenetic stock traders. Come back to this page on a periodic basis to check on the latest direction for these indicators and get early clues for whether the economy and stock market may be headed next. This page is a supplement to the shorter-term signals from Above the 40.

Be careful out there!

Full disclosure: no positions

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