Understanding the US Employment Report

The employment report is the single most important US economic data release. The importance of this release is due to its timeliness (the report comes out ahead of most other monthly economic data) and its scope (it is the result of a two large surveys: the household survey of 60,000 households and the establishment survey of 160,000 businesses and government agencies covering 400,000 work sites). The report is viewed by some analysts as a sort of monthly GDP number, due to the strong correlation between employment and growth.

This article will not make you an expert analyst of this report (if you want to be an expert I would suggest a year or more of graduate school in economics followed by a year or more working at the economics department of a bank or investment bank as a better start). But it will tell you a few things to look for and provide you with some context to understand what it means.

First, as was noted above, there are two surveys. One of them (the establishment survey) gets most of the attention from traders. The key number (announced, with the rest of the data at 8:30 am Eastern Time on the first Friday of every month and available shortly thereafter here) is the change in nonfarm employment, or the change in the number of workers as calculated by employers and adjusted by the Labor Department. There is much speculation about this number, and if it is greater than expected (and greater than the so-called “whisper” number that certain traders circulate just before the official number is released) then typically equities will rise (in general, strong economy, strong stocks) and bonds will fall (strong economy, more likely that the Fed will raise rates).

But while markets react quickly to this number, it is somewhat controversial, for several reasons: (1) the imprecision of the initial estimate; (2) problems in counting new businesses and the self-employed; (3) the timing of employment relative to the business cycle. I will now discuss the criticisms of the headline number in turn, and then discuss other parts of the report:

Imprecision: The establishment survey is revised in the two months following the initial release (as well as several more times in later years). For example, in September 2006, the initial number was +51,000, a number described as “dire” by one analyst. But in October, this number was revised to +148,000 and in November it was revised again to +203,000. Presumably the analyst viewed the revised number a bit differently. During 2006, the range of the revisions (see here for a table) from the initial announcement to the second revision was from -43,000 to +152,000. The Bureau of Labor states that a 104,000 monthly change is statistically significant. All this implies a bit more randomness in these numbers than some analysts seem to believe. A further complication is that the news from the headline number is often offset by recent revisions; if the headline number is below expectations, but the two previous months have been revised up, is that good news or bad? Thoughtful traders may conclude that markets tend to overreact a bit to these numbers.

New Business and the Self-Employed: Since the establishment survey works with existing businesses it cannot measure newly-formed businesses or count the self-employed. The Department of Labor attempts to correct for these omissions by including an adjustment to the numbers for these factors, based on a model. Analysts who believe that the economy is weak tend to argue that these adjustments overstate employment.

Timing: Many companies may attempt to keep workers even after business has turned down. It is expensive to find, hire and train workers; despite all the announced layoffs by firms who have experienced losses, the evidence suggests that many firms prefer to maintain workers on their payrolls even when demand for their products is down so that they will be prepared for the next upturn. Thus, the economy may turn down before employment actually drops. Similarly, when the economy has started to turn up, firms may be reluctant to hire workers until there is ample evidence that business is good. Economists believe that the decision to hire and fire a worker is viewed as an investment project, differently from the decision to buy supplies for the office. A business that is losing money due to a lack of customers can sell off their extra supplies that will not be needed, confident that when business is better they can buy new supplies at the going price. But a company will try to avoid firing workers because there is a significant cost to finding and training new workers.

As I have noted above, the employment report is much more than the headline number from the establishment survey. I will briefly mention two other parts of the report that attract attention, the household survey and the index of hours worked.

The household survey is used to calculate the most politically important number, the unemployment rate. The household survey asks people who are not employed whether they were available for work and have made specific efforts to find employment during the past four weeks; they further state that whether an individual is eligible for unemployment benefits does not enter into their analysis. The household measure of employment is much less accurate than the establishment survey, with a 90% confidence interval of plus or minus 430,000, so it is usually ignored by most market analysts, but the unemployment rate (particularly among certain groups like minorities or women) can be a very important number for political analysts. Fed Chairman Greenspan used to pay attention to the rate of job leavers (see Table A8), the percentage of workers who left a job voluntarily; he believed that this was an indicator of the strength of the labor market.

The index of hours worked (see Table B5) attempts to measure not just how many people are working but how much total work they are doing. The Labor Department calculates how many hours per week nonsupervisory workers are working and then creates an index. While heroic assumptions must be made to create an index (similar to the assumptions of any index, in which very different things are summed together), this is an interesting monthly indicator or the US economy. It somewhat accounts for the timing problem cited above, in that firms can adjust how much work is done (via a shorter work week) more easily than adjusting the number of workers.

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