In July, job losses were lower than expected and the unemployment rate fell for the first time since 2008. Since then, an increasing number of surveys have pointed to the end of the recession. All of this has boosted hopes of a "V-shaped recovery" accompanied by a rapid fall in unemployment. We believe that this analysis is far too optimistic. The US economy probably emerged from recession during the summer, and US economic activity is set to rebound significantly by the end of 2009 but this is driven primarily by temporary factors (policy stimulus and the inventory cycle). Looking more closely at the data morever, the employment statistics show that the labor market continues to deteriorate. The 6.7 million people who have lost their jobs since the start of the current recession will not get back to work rapidly, and the rise in unemployment, which is putting pressure both on wages and banks balance sheets, will jeopardize the recovery.

No stabilization of the unemployment rate any time soon…

The slight drop in the unemployment rate recorded in July (from 9.5% to 9.4%) is the result of the decline in the labor force, which is in turn explained by a lower participation rate (ratio of the labor force divided by the working age population).

To illustrate this point, we calculated what the unemployment rate would have been if the participation rate had remained at the same level as at the start of the recession. The adjusted unemployment rate would have then exceeded the symbolic 10% threshold in July. In fact, the participation rate behind this calculation (66.0%) is not very elevated by historical standards and is below the average level over the last 25 years. Many people have simply given up looking for work, presumably discouraged by the difficult economic conditions. These workers are no longer included in the labor force, rendering the fall in the official unemployment rate rather misleading.

This conclusion is supported by other indicators. First, long-term unemployment is rising rapidly: the average duration of unemployment has not been so high since WW II. Second, the number of people working part-time jobs for economic reasons is at record high. All in all, the US labor market is in its worst shape since the Great Depression. For the moment, the pace of US job losses has eased, but so far there is no sign of a turnaround in hiring. Due to its inexorable population growth, the US economy needs to produce at least 100,000 jobs per month just to stabilize the unemployment rate over the long term. A return to such job growth appears highly unlikely before mid-2010.

…which will jeopardize the recovery

The labor market’s continued deterioration has many consequences. First, wage growth is quickly slowing. Hourly compensation as measured in the national accounts decreased by 1.1% at annual rate during H1.09, which has not been seen since WW II. At the same time, as long as unemployment remains high, household purchasing power will remain under huge pressure. As observed in the previous cycles, unemployment tends to lag the recovery. However, the current cycle is set apart by the severity of the associated credit crisis.

In addition, the number of home foreclosures continues to rise in particular for prime households. This is largely attributable to the sharp rise in unemployment. As such, the banks are also seeing the quality of their loan portfolios suffer, hindering new loan production. Indeed, the latest quarterly Fed survey (Senior Loan Officer Opinion Survey on Bank Lending Practices) shows that credit conditions remain tight and are only easing very slowly. In such an environment, a lasting rebound in economic activity is not guaranteed. To prevent the economy from falling back into recession, the Fed will no doubt prefer to wait for an improvement on the employment front before starting to raise its key rates.