As noted in “Productivity and employment” (Active Trader, January 2012), nearly all economic data, and by extension many of the movements in financial markets, begin with employment.
One of the article’s surprising conclusions was that policies designed to stimulate the economy via low interest rates often have the counterproductive effect of making capital cheaper relative to labor and, therefore, reduce domestic employment growth.
Overall, we concluded rising productivity as the result of cheaper capital and improved technology provided a strong headwind for employment growth and explains a three-decade-long secular decline in normalized employment growth (highlighted with a turquoise trendline in Figures 1 and 2), which is the year-over-year changes in employment adjusted for growth in the civilian population.
Let’s shift the driving independent variable from nonfarm productivity to the relative cost of corporate debt capital as measured by either the forward rate ratio (FRR) or the absolute yield spread between one-year Treasuries and Moody’s Baa-rated yields as reported by the Federal Reserve (Figure 1). As the bonds in this Moody’s index have maturities ranging between 20 and 30 years, we will use an FRR between one and 20 years (FRR1,20); this is the rate at which we can lock in borrowing for 19 years starting one year from now divided by the 20-year rate. The more the FRR1,20 exceeds 1.00, the steeper the yield curve is.
Both the yield spread (Figure 1) and the FRR1,20 (Figure 2) lead changes in normalized employment by 24 months on average. The two measures of the corporate yield curve have a different relationship to normalized employment growth. Both a wider spread and a steeper FRR1,20 are associated with rising normalized employment growth, but for different reasons. In the former case, higher corporate credit demands are associated with prospective hiring as business conditions improve. In the latter case, the Federal Reserve drives short-term financing costs lower in an attempt to maintain operating margins. Restated, the spread is driven by corporate actions at the long end of the yield curve while the FRR1,20 is driven by Federal Reserve actions at the short end of the yield curve.
For the complete article, see the February 2012 issue of Active Trader magazine. Click here to subscribe.
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