Vital Signs: Employment Outlook Gets Gloomier

On deck: Election Day, ISM indexes, construction spending, car sales, productivity, pending home sales, consumer credit, and the employment report

By James Cooper

It’s election week, and investors will finally get a look at the political backdrop the markets will be facing for the next few years. However, as important as that is, market attention will be more tightly focused on the first round of major economic reports for October. So far, there has been little hard evidence on how the market upheaval following the Sept. 15 bankruptcy of Lehman Brothers has affected spending, hiring, and production decisions by consumers and businesses. Surveys by the Institute for Supply Management on manufacturing and nonmanufacturing activity will offer key readings early in the week, but the markets will be especially interested in the Labor Dept.’s employment report.

The 0.3% decline in third-quarter real GDP, led by a 3.1% drop in real consumer spending, was evidence of the unfolding consumer-led recession. From here on, the extent of the weakness in the job markets will determine just how severe the downturn will get. Job losses picked up speed in September, as payrolls fell 159,000, after moderate declines averaging only 75,000 per month from January to August. For October, a number of job market indicators, especially weekly claims for unemployment insurance, suggest payrolls could drop by some 200,000. Weekly jobless claims have marched higher in recent weeks to levels that are already approaching the peaks reached in the 1990-91 and 2001 recessions.

Given that the worst of the declines in real GDP are still in the future, as businesses continue to adjust to falling demand, the upward pressure on the unemployment rate will not abate. Based on past recession patterns, the jobless rate tends to rise, on average, about three percentage points from its low point to its peak during a business cycle. The rate is already up to 6.1% from its 4.4% low last year, suggesting an unemployment rate in the neighborhood of 7.5% sometime next year would be consistent with the average recession experience.

Businesses are cutting back on hiring to cut costs and keep productivity up, as pressure on profits intensifies. Those efforts will show up in this week‘s Labor Dept. report on third-quarter productivity. We already know output in the nonfarm business sector fell 1.7% last quarter, while hours worked shrank an even greater 2.2%, suggesting a slight rise in productivity. However, output is expected to drop even faster this quarter. So, if businesses are going to avoid a big dropoff in productivity, they will have to make even deeper cuts to payrolls.

Rounding out the week’s key reports, October car buying is expected to post another weak showing. Sales averaged a 12.9 million annual rate in the third quarter, and October buying is expected to start the fourth quarter below that pace. Also, September pending sales of existing homes will offer a clue to October sales. Finally, consumer credit, which has long been a low profile economic report, is attracting more attention amid the credit crisis and retrenching consumers. Credit outstanding plunged $7.9 billion in August, the largest drop on record and the biggest percentage decline in more than ten years.

Here’s the weekly economic calendar, from Action Economics: