Citi ‘Shadow Unemployment Number’ Has Interest Rate Implications

Citi ‘Shadow Unemployment Number’ Has Interest Rate Implications

As charges that government unemployment numbers were manipulated leading into the 2012 presidential election were made, and a continual cry that the unemployment numbers don’t accurately reflect those who simply stopped looking for a job, a new report from Citi investigates claims that the rapid decline in the unemployment rate overlooks substantial remaining slack in the U.S. labor market.

The U.S. workforce continues to recuperate from the financial crisis however the speed of recovery is up for debate,” the Citi report noted. “We define a shadow unemployment rate due to certain types of underemployed workers who are not counted as part of the official unemployment rate.”  This includes part-time employees working fewer hours than they wish and workers who recently left the labor force but are prepared to reenter when conditions improve.

In his recently released book Leading Indicators, author Zachary Karabell augments Citi’s thesis, noting that the relatively recent phenomenon for dependence on headline numbers to guide political and investment decisions is flawed and reliant on foggy data at best.  The author notes the unemployment rate doesn’t include unemployed individuals who have given up looking for work or who are underemployed, and GDP numbers can be suspect and inflation indexes are subject to manipulation in what they exclude, as reported yesterday in ValueWalk.

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Citi “shadow” unemployment not much different from official version

If you are expecting the Citi shadow unemployment to reveal a significant difference between the officially reported number, don’t hold your breath.  The current Citi estimate of the “shadow unemployment” rate is 7.1 percent, just a ½ percentage point above the official rate.  That small of a difference between the reported and shadow number might surprise people. “While a 50 basis point adjustment is not trivial by any means, it is also far smaller than suggested by other broader measures of unemployment,” the report said.  “All told, our deep investigation of these sources of underemployment reveals surprisingly little cyclicality over and above standard measures of the unemployed. As a result, the shadow unemployment rate will likely provide only a moderately sized buffer to wage and inflation pressure as the economy continues to improve.”

Pace of unemployment decline questioned

The Citi report tackles a current rapid decline in unemployment, which currently at 6.6 percent.  “The official unemployment rate has fallen faster over the past year than many observers expected, including the Federal Reserve,” the report said. “Although this is good news on its face, the fact that the decline has been driven by workers exiting the labor force has called into question whether it truly represents the labor market’s improving health.”

The report notes recent debate centered on whether the fall in labor force participation since the Great Recession is a structural phenomenon driven by long-term demographic trends – an aging population reaching retirement age, for instance – or whether those workers who exited the labor force stand ready to reenter when conditions improve.  “We view this as a very important question, but one that is difficult to prove convincingly one way or the other. At a minimum, the evidence suggests an important role for structural factors.”

Citi notes the implications of the shadow employment rate that interest rates could remain artificially low for a longer period of time.  “Specifically, an additional ½ percent of unemployment could cause policymakers on the FOMC to maintain a policy stance that is looser than suggested by the official unemployment rate alone, and potentially delay the fed funds rate’s lift-off from zero,” the report noted. “We also note the possibility that additional labor market slack has been translating into lower wage growth and inflation, which would also hold interest rates at bay.“

Unemployment taylor

Taking this further to quantify the effect of additional slack on the path of the fed funds rate, the report plugs their shadow unemployment rate into a standard monetary policy rule, the Taylor rule. “The key is that the additional slack will increase the difference between the current unemployment rate and the long-run natural rate,” the report observed. “According to our specification of the Taylor rule, that difference passes through into the fed funds rate with a multiplier of 2. (See chart above. Source: Citi). Thus, the extra 50 basis point difference in the shadow unemployment rate implies a fed funds rate that is 100 basis points lower.”

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Mark Melin is an alternative investment practitioner whose specialty is recognizing a trading program’s strategy and mapping it to a market environment and performance driver. He provides analysis of managed futures investment performance and commentary regarding related managed futures market environment. A portfolio and industry consultant, he was an adjunct instructor in managed futures at Northwestern University / Chicago and has written or edited three books, including High Performance Managed Futures (Wiley 2010) and The Chicago Board of Trade’s Handbook of Futures and Options (McGraw-Hill 2008). Mark was director of the managed futures division at Alaron Trading until they were acquired by Peregrine Financial Group in 2009, where he was a registered associated person (National Futures Association NFA ID#: 0348336). Mark has also worked as a Commodity Trading Advisor himself, trading a short volatility options portfolio across the yield curve, and was an independent consultant to various broker dealers and futures exchanges, including OneChicago, the single stock futures exchange, and the Chicago Board of Trade. He is also Editor, Opalesque Futures Intelligence and Editor, Opalesque Futures Strategies. - Contact: Mmelin(at)

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