The labor market has been one of the hardest hits sectors of the real economy during the credit crisis, with the same trend being seen in most of the developed economies. The history of labor reporting indicates that employment is a lagging indicator of economic health, where the slack in an economy has to be absorbed before growth then leads to hiring. With that accepted, there is still a lot of pain in the labor market that is not being tempered by economic expansion signals.

From the very low and stable unemployment rates seen during the 2006 and 2007 period, the last two years have created major pain in the labor market. In particular the U.S. the unemployment rate that has more than doubled since 2006, from approximately 4.5%, to October’s 10.2% rate.

The pace at which the labor market deteriorated in the U.S. is startling and reflects the shock that both the business environment and household had to bear. The deterioration was observed in the Euro-area although not to the same percentage degree, where the unemployment rate moved from 7% in late 2007 to 9.7%, while in the U.K. the rate moved from 5.5% to 7.8%. in the same period.

Interestingly, Australia, which has avoided the eye of the credit crisis storm with great success, is the only country among the developed economies in which the unemployment rate at the beginning of 2006 was higher than the one recorded in September 2009; 5.3% versus 4.8%. The huge discrepancy between the Australian economy and the others explains the stellar performance of the Australian dollar since the beginning of 2009.

Current forecasts for the U.S. unemployment rate run as high as 13%, which would mean that it is heading towards the highest level since World War II. Accepting the lagging indicator effect, that still leaves question marks over U.S. growth rates compared to the major economies, with the chart showing a dramatic surge in U.S. rates since mid-2008, compared to the controlled moves higher in the U.K. and Euro-zone. The U.S. unemployment outlook far exceeds estimates for percentage changes of the other regions.

Much of the U.S. economy is based on consumer spending, which is directly linked to the unemployment rate. With the number of unemployed on the rise, consumption will reduce due to financial insecurity. The reverse also holds true, when the unemployment rate is falling or stabilizing, consumer spending tends to rise.

The direct effect of the surging unemployment rate/declining spending is reflected in the GDP numbers. The formula of the GDP is very straightforward: Y=C+I+G+(X-M)

Where Y = GDP

C = Private Consumption
I = Investments
G = Government Spending
X = Exports
M = Imports

The largest component of GDP is private consumption, which is directly influenced by consumer’s spending behavior. In the third quarter, the private consumption component was almost 60% of U.S.GDP, but the single largest gain came from the "Motor vehicles and parts”, which was responsible for a third of GDP’s total advance. However, this surge was almost entirely triggered by the "Cash for Clunkers” program, which will not be there during the next few quarters.

That is another reason that the unemployment lagging indicator theory may be flawed in the current environment; GDP growth was synthetic, it came from a one-off stimulus that lowered inventory, but did not increase output demands, and therefore created no forward momentum that will impact near-term employment reads.

With the biggest component of GDP likely to have a very slow growth rate ahead due the move higher in the unemployment rate, the recovery of the U.S. economy will be slow and bumpy. Nothing really new there, but a slow recovery means that interest rates will not be able to go higher any time soon. That is something that will increase the U.S. dollar outflows towards the higher yielding emerging economies, which right now seem in a very strong position compared to the ‘developed’ world in regard to potential for growth.

The employment reads may lag, but at these high rates the U.S. economy still has a lot of slack to pick up, and that may lead to the equity markets stalling as questions are raised as to how companies will find ways to pretty-up their books for January earnings. It certainly does not look possible for profit to come from top-line growth, the hiring rate tells us that, and therefore we are back to looking at the unemployment read as maybe more of an economic litmus test than many would initially think.

If forward earnings and unemployment questions remain unanswered and a drop in equities happens, the main beneficiary will the dollar against the Gbp, Eur, Chf, Cad, as risk aversion sends trade desks to bonds and U.S. Treasuries. That in turn will take the heat out of commodity prices, and with gold bought recently as a Usd weakness play rather than an inflation hedge, the precious metal may easily test $1000 an ounce.

It is to the emerging markets that we will look for growth and expansion, and to those economies to take their rightful place at the table of global leaders. The emerging economies look to have learned their lessons from the Asian and Latin American crisis points of the 1990’s, and are now in a strong position to print growth and expansion ahead of the developed world.

The unemployment rate is now the focus of more attention than has been the norm, and rightfully so because it may actually become a leading indicator in the unique economic and trading arena that the credit crisis has carved.

Written by TheLFB Trade Team, © 2007-2008 LFB Services, LLC. All rights reserved. http://www.TheLFB-Forex.com