As traders, we track the monthly Employment Situation report closely. The market often does a short-term move on the first Friday of every month when the Employment Situation report for the previous month is released. Do you understand what the Employment report is showing? I bet many traders do not. As traders, we have to know a bit of macroeconomics, so we don’t make the wrong decisions with our money. Let’s briefly look at what the Employment Situation report shows.

There are different types of unemployment. When we talk about unemployment, most traders default to what is called cyclical or demand deficient unemployment.

Cyclical unemployment exists when individuals lose their jobs as a result of a downturn in aggregate demand (AD). If the decline in aggregate demand is persistent, and the unemployment long-term, it is called either demand deficient, general, or Keynesian unemployment. Demand deficient unemployment is caused by a lack of aggregate demand, with insufficient demand to generate full employment. Demand deficient unemployment shifts the AD curve left (inward) from AD to AD1.

unemployment-supply-demand-graph

GDP contracts from Y to Y1 and wages fall from P to P1. If wages “stick” at P rather than fall to the new equilibrium wage of P1 following a shift of demand, the result will be a much greater unemployment equal to Y – Y2.

supply-demand-graph-cyclical-unemployment

Frictional unemployment is not caused by a reduction in aggregate demand. Frictional unemployment is due to people being in the process of moving from one job to another. The time, energy and monetary cost of searching for a new job is called friction. Friction is an unavoidable aspect of the job search process. Friction is a natural part of seeking new employment, but friction is typically short-term.

When most traders get the monthly Employment Situation report data of something like 150K jobs created in October, they don’t realize that those are net changes. What actually happened is that there are around 5 million new hires during the month, and 4.85 million new separations (quits or layoffs). The number you hear about each month is the net number or the difference between new hires and new separations. The net number is misleading. The net number hides the vast amount of job change which is happening.

Every month millions of people quit their jobs to get a new job. Some go back to school for more training and some retire. Other people start new jobs after graduating or finding new opportunities. This all leads to frictional unemployment and it’s a healthy part of a dynamic economy.