Unemployment Rate: why is it so important for the Markets?


12 April 2023 - 10:47

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Is there a relationship between the unemployment rate and the performance of the stock markets?

Unemployment Rate: why is it so important for the Markets?

The unemployment rate, in addition to being an indicator of the state of health of a given economic area, is also used as a market mover by investment funds and institutional operators. In this article we will look at why and how the unemployment rate and its long-term trend influence the stock market trend, as a sentiment indicator.

Unemployment rate and other macroeconomic factors

When we talk about macroeconomic data it is our absolute duty to contextualize them and look for links that make sense from an "academic" point of view. We remind you that when we talk about academic sense in the macro sphere we are referring to the links that exist between the various macroeconomic factors, the result of ten-year studies and research by professionals in the field of academic training and research, therefore the fruit of scientific studies based on the historicity of economic events.

Economics "is not an exact science" as many argue as it is mainly driven by consumer habits (economy) and market sentiment (finance). The fact is that the basic macroeconomic links are solid and the relationships between the main macro data still remain "certainties" in this area, with the only great unknown factor being time, the famous "timing" of an event.

In this case we are talking about the correlations that exist between interest rates, inflation and the unemployment rate, three factors that are truly correlated to each other and which link finance (interest rates) to the real economy (inflation and the unemployment rate). In this sense we see a sharp increase in interest rates on a global scale, all mainly focused on bringing down inflation.

Up to here everything is clear, central banks are raising rates in order to lower inflation. But what happens to the economy when rates rise and inflation falls?
In practice increases the cost of credit, i.e. the cost of mortgages, corporate loans, personal loans, credit lines. All this would lead to a slowdown in the speed of circulation of money, an essential element for inflation. It follows that an economic slowdown is the result of an increase in rates and that inflation is the result of this slowdown.

When the economy slows down, difficulties begin and the most important recession/slowdown indicator we have is precisely the unemployment rate, a figure which is in fact directly influenced by inflation and interest. Logic has it that when we see an increase in the unemployment rate, we should logically prepare ourselves for a period of severe economic slowdown.

Markets and unemployment rate: historical examples

As far as the logic of these quantities is concerned, we don’t have much to say, we cannot deny that these quantities are interrelated and this would make economics a "partially exact science", except for timing, as we said previously.

With regard to the performance of the financial markets, we could note how historically there has been a relationship between the unemployment rate and market performance, especially in situations of tension in terms of interest rates and inflation.

We recall the “Dot com” bubble, which saw the Nasdaq as the protagonist and the quotations of tech companies reach astronomical figures, effectively fueling a bubble due to the fever for tech companies on the capital market. In this case, during the bubble, the unemployment rate was clearly declining, reaching lows right at the Nasdaq market highs.

As there was a stock market drop, we saw a rise in the unemployment rate, which lasted until the Nasdaq made all-time lows over the months after the bubble burst.

The same thing happened between 2007 and 2009, a period historically associated with the subprime mortgage crisis and the consequent banking crisis that led to the definitive bankruptcy of Lehman Brothers, one of the largest investment banks USA. Here, too, markets were up and unemployment rates down. Upon reaching the lows of the unemployment rate we saw the generation of highs on the stock market and the consequent decline was associated with a rise in the unemployment rate.

Attention, we do not know which of the two variables, ie stock markets and the unemployment rate, influences the other, but we can safely say that we see a rather obvious negative correlation. A rise in the unemployment rate corresponds to a decline in the stock market, conversely a decrease in the unemployment rate corresponds to an increase in long-term share prices.

In practice, the unemployment rate could be seen as a true long-term "indicator".

The unemployment rate today and the impact on the markets

Especially in this very particular and unusual macroeconomic context, we see markets quite undecided on what to do. Many are bullish and just as many are bearish, a real battle between "bears and bulls", something usual in agitated market phases such as the ones we are experiencing in recent weeks, where we see bullish markets against all odds, as if the market was waiting to see a sudden change in sentiment that would help form new liquidity as a "counterparty" on the market.

Basically, we could see what we call “Bull Trap”, i.e. a bullish trap that could serve as a driving force for the formation of a very important bearish impulse.

At this historic moment we see an unemployment rate at an absolute low for some years now and a macro situation that is willing to see its increase in the long term.

Most likely, according to what has been seen historically, the market is in a phase of highs and an increase in the unemployment rate could lead to a possible new drop in share prices, a drop that could be much worse compared to that seen last year with the blockage of the supply chain and the outbreak of the Russian-Ukrainian conflict.

We’ll see how the situation will evolve and only time, that variable that makes the economy an "inexact science" will tell us if this correlation makes sense to exist.

Original article published on Money.it Italy 2023-04-07 19:31:00. Original title: Tasso di disoccupazione: perché è così importante per i mercati?

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