What is the Unemployment Rate?
The unemployment rate is the lagging indicator that determines the strength of the US economy, and in turn, the strength of the US dollar. In its simplest form, it is the total number of unemployed in the Non-Farm segments divided by the total labor force. The number is expressed in percentage format and is declared by the Bureau of the Labor Statistics on the first Friday of every month. As expected, it rises during cyclical downturns and falls during periods of rapid economic growth. It is a lagging indicator as the rate peaks after the trough of the business cycle, and bottoms after the peak are formed.
Why is it Important?
The unemployment number is critical as it is a salient metric that helps Federal economists to monitor and modify the US Government’s economic and fiscal policies. If the rate is too high, the Feds will try to stimulate the economy by either: (1). Implementing job creation programs, or (2). Lowering Federal fund rates, or (3). Instituting fiscal policy measures, such as tax cuts, and extended unemployment benefits. In any event, the high unemployment rate is an indication of weakened US economy and US dollar alike. For example, the unemployment rate was above 6%, when President Obama initiated a series of Quantitative Easing Measures to jump-start the economy. These three Quantitative Easing measures coupled with a mini-boost (Operation twist) helped to bring the unemployment rate to today’s lowest rate – as low as lower than 4%.
- QE1 (12/2008 – 06/2010): $1.25 trillion in MBS, $300 billion in long-term Treasuries
- QE2 (11/2010 – 06/2011): $600 billion in long-term Treasuries
- Operation Twist (09/2011 – 12/2012): $400 billion in long-term Treasuries
- QE3 (09/2012 – 10/2014): $85 billion monthly in long-term Treasuries, $40 billion monthly in MBS
Unemployment Rate’s Impact on US Dollar
Lower than expected unemployment rate leads to more income earning workers and an increase in consumption expenditure that may fuel inflationary pressures, and cause interest rates to rise. High levels of unemployment results in lower incomes, decreased consumption and a drop in economic activity. Thus, a drop in the unemployment rate is generally considered to be positive (or bullish) for the USD, while a rising figure is seen as negative (or bearish) for the currency.
For example, as shown above, when the unemployment rate was around 6% between 2002 through 2008, the USDIX was also higher – in 90% to 100% range indicating inflationary pressures. To curb unemployment rate, and the Mortgage bubble, President Obama implemented a series of Quantitative measures, QE1 through QE3, that brought down the unemployment rate, lower interest rates, and correspondingly lower unemployment rates since 2010. US economy was correspondingly weak though recovering during this period as indicated by lower US Dollar Index. And, now at the end of the recovery period, the unemployment is at its lowest, US dollar Index is slowly recovering, and inflation pressures have started surging.
What is Next for US Dollar and US Dollar FOREX Rates?
The following table shows the projected FEDS plans for rate hike during 2018.
The Global currency markets follow the Wealth Accumulation Axiom (WAA). The wealth accumulates, where the investors find the most rewards. Hence, in this case, as the US yields increase and the US Dollar strengthens the Global money starts flowing into US markets. This further strengthens US dollar, weakening other currencies in comparison. Hence, as one evaluates the above FEDS rate projections, the USD is expected to strengthen continually in 2018 with its corresponding better exchange rate against other world currencies.
In view of the above discussion, it is not surprising that EUR/USD has been losing grounds over the last couple of months as shown below and will possibly continue to remain weaker as the FEDS increase the discount rate resulting in higher yields. The above observation is further reinforced as one views the USD/JPY price chart. As shown, below the Japanese yen has been losing ground against USD over last one month or so,
The above is, albeit, macro-level discussion on the unemployment rate and FX markets. Evidently, the FX markets are exceedingly more complex and require a detailed understanding of macroeconomics, micro-level behavior of currencies, geo-political variations, and human psychology.
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