Job losses were horrible, but jobs are a lagging indicator

Today's employment report was simply awful—a loss of 524K jobs according to the establishment survey, and a loss of 854K jobs according to the household survey—but it was also in line with expectations. Financial markets collapsed starting last September in anticipation of a mega-depression, and what we've seen so far is merely a nasty recession. Jobs are going to have to continue to fall at this pace for quite some time before a mega-depression sets in, but that's the fear that is making everyone sick to their stomach.

It's always tempting to project that current conditions will continue in the future, but to do so is to ignore how all the things that have happened change the dynamics of the economy going forward. Houses were terribly unattractive a few years ago, but now they are much cheaper and financing costs have dropped to new all-time lows. Surely there are many would-be homebuyers who were depressed two years ago but who are getting excited today. With cash now yielding zero and equities, corporate bonds and emerging market debt now yielding far more, investors are being offered a mighty incentive to take risk again. Banks have an almost unlimited supply of reserves to support new lending, and it's hard to believe they won't try to seek out new business; already we see significant growth in all measures of the money supply.

Financial markets are almost always the first to react to a change in the fundamentals. Large-cap stocks began falling in the second half of 2000, and job losses began showing up in April 2001. Stocks began rising in the first half of 2003, and jobs started turning up in October 2003. This chart shows a similar pattern. Stocks collapsed in October as fear gripped the financial markets. This fear spread to the general public; consumers sharply pulled back on their spending; businesses reacted by laying off workers. There's a lag of some 3-6 months between the time financial markets react to changing conditions and the time that businesses become convinced that conditions have changed enough so that they need more workers or fewer.

So it's not unreasonable at all to think that the recent improvement in financial market conditions (e.g., lower swap and credit spreads, reduced volatility, higher prices for corporate debt and equities) is a leading indicator of improved conditions in the labor market that should begin to show up in the next several months. We've already seen commodity prices turn up, and that may be the very first indicator that the economy is putting in a bottom.