Conventional wisdom says higher unemployment indicates economic weakness, so the currency responds accordingly. But if it were that easy, Forex wouldn’t require so much analysis and study. A lower unemployment level means the economy grows and the currency strengthens. However, the currency wouldn’t require much study and analysis if it were that easy. As the analysis is added to central bank action, there are complications.
When employment rises enough, the economy is overheating, and inflation rises. This could result in interest rates being raised by the central bank, further strengthening the currency. The next complication is structural unemployment. Because so many economies are experiencing such low unemployment, traders and analysts, who have been used to relatively high unemployment for nearly a decade, may overlook this critical factor.
What is Structural Unemployment?
A free market economy means that unemployment cannot be zero. Companies will inevitably close units, and new processes and technologies will create redundancies. Furthermore, there are bankruptcies, employees searching for better employment prospects, and people simply unable to find work.
Inevitably, there will be some level of unemployment, referred to as “structural unemployment.” The level of structural unemployment varies based on circumstances and by economy. Economists generally agree that structural unemployment will be between 4% and 6% in a generic, advanced economy. It is unclear what the structural level of unemployment is for any given economy at any given time. However, there are exceptions, such as Switzerland, which rarely has unemployment levels in that range. Due to the Fed’s mandate to keep unemployment “low,” this poses a particular challenge for the US. The academic debate aside, some real-world issues directly relate to forex that concern us much more. (What exactly is “low” when even Fed members can’t agree on where the structural unemployment level is?)
Structural Forex
Reducing unemployment to a structural level causes the economy to face particular challenges. When businesses can’t find good employees (a condition known as “labor tightness”), they have to raise wages without increasing production. Because labor costs are on the rise, this leads to inflation and currency depreciation. However, it directly affects exports. As a result of falling unemployment, businesses may not be able to hire people to do work because there are just not enough people to do so. This means that work goes undone, resulting in a reduction in economic growth. Conventional wisdom says less unemployment is good, but structural unemployment limits economic growth. Lower unemployment numbers have less of a “benefit” on the currency the closer the economy gets to structural unemployment. A good labor figure can catch traders off guard if they expect the currency to rise in response.
Bottom line
An economic shift can lead to structural unemployment, which is long-term. Unemployment occurs because employers and workers have different needs despite available jobs. Usually, structural unemployment requires a radical change to be reversed after a few decades. In addition to increasing structural unemployment, technology marginalizes certain workers, making specific jobs obsolete, such as manufacturing. Furthermore, structural unemployment is also a harbinger of a correction, if not an outright recession. This is another reason traders should pay attention when structural unemployment is being discussed!
