US: Should the Fed worry about the LMCI? – Deutsche Bank

Research Team at Deutsche Bank, suggests that for just the eighth time in nearly four decades, the annual change in the Fed’s Labor Market Conditions Index (LMCI) has turned negative.

Key Quotes

“Five of the previous seven occasions were associated with the five recessions that have occurred during the history of the index, while there were only two “false alarms”. For this reason alone, investors should guard against complacency about the ostensible health of the labor market.

On the surface, the labor market is healthy. Jobless claims are hovering near four-decade lows and the unemployment rate (4.9%) is just a shade above the Fed’s median estimate of the natural rate (4.8%). Moreover, nonfarm payroll growth has averaged 232k over the last three months and 182k year-to-date. As a result, several Fed speakers have delivered upbeat assessments of the labor market. The Fed’s LMCI, however, suggests that caution is warranted.

The index has declined in seven out of eight months this year and is down slightly on a year-over-year basis, which is noteworthy. The 12-month change in the LMCI has turned negative on eight occasions including the present. Of the seven previous occasions, four were soon followed by recession.

In other words, each of the five recessions that have occurred in the nearly four-decade history of the LMCI have corresponded with negative annual momentum in the index. In four cases, the latter led the former, with lead times of three, thirteen, five and two months, and in one case there was as lag of two months. Importantly, there have been no false negatives (recessions without a negative 12-month change in the index) and only two false positives, which occurred in March 1986 - January 1987 and October 1995 - April 1996.

The upshot is that the economic outlook remains fragile despite the perceived robustness of the labor market. Although we remain hopeful that the recent trend in the LMCI is merely a false alarm, we believe that in addition to the very weak recent GDP growth profile, it is yet another reason for the Fed to maintain its cautious approach to policy normalization.”