Investors and Wall Street economists alike anxiously await key labor market data, usually released on the morning of the first Friday of the month. While the “nonfarm payrolls” dataset is a backward-looking snapshot of the health of the macroeconomy, it still gives investors important clues. The vast survey includes many nuggets, including a host of unemployment rates (and you thought there was just one!). 

The labor market is complex with many moving pieces. New entrants - perhaps recent college graduates, immigrants, or even formerly stay-at-home parents - can result in labor market expansion. On the other hand, a boom in retirements, an increase in people going back to school, or an uptick in discouraged workers might cause the size of the labor pool to shrink.

Defining the Civilian Labor Force, Labor Force Participation Rate, and An Unemployed Person

The unemployment rate, at least the one that is widely discussed among financial pundits and in mainstream news outlets, is what’s known as the “U-3” rate. The U-3 unemployment rate, calculated from data collected in the monthly “Household Survey,” gauges the number of out-of-work individuals actively looking for a job in the civilian labor force. Information gathered by the U.S. Bureau of Labor Statistics (BLS) is used to track the nation’s employment status and determine social insurance benefit payouts.

But what is the civilian labor force? According to the BLS, the civilian labor force is the number of employed and unemployed individuals age 16 and older. In essence, it represents those working or actively seeking employment. The labor force participation rate is thus the percentage of working-age people actively engaged in the labor market.

The labor force participation rate is also a key barometer of the well-being of the economy. Policymakers both at the Federal Reserve and in Congress must keep a close watch on its trends. Likewise, business owners may be impacted by changes in this rate and the size of the civilian labor force when seeking to expand. When mass layoffs take place during economic contractions, the labor force participation rate might fluctuate greatly.

We must also define what exactly constitutes an unemployed person. The BLS says that people are deemed to be unemployed if they were not employed during the bureau’s survey week, they were available for work during that period (except for temporary illness), and they made at least one active effort to find a job during the four weeks ending with the survey week or they were temporarily laid off and expecting to be recalled to work.

All Measures of Unemployment

The U-3 and U-6 rates are by far the most widely publicized indicators, but what about all the others? Each calculation defined and calculated by the BLS offers its own insights. Let’s outline what they are and how they might be used by investors and economists alike.

• U-1: People unemployed for 15 weeks or longer, expressed as a percentage of the civilian labor force.

• U-2: Unemployed job losers (those temporarily laid off, recently completed a temporary job, and the permanently unemployed) as a percentage of the civilian labor force.

The above pair of rates are narrow measures of labor utilization and include only certain subsets of people classified as unemployed.

• U-3: This is the official unemployment rate. It’s the total number of unemployed workers divided by the civilian labor force. 

• U-4: Building upon the U-3 headline rate, the U-4 percentage’s denominator includes discouraged workers who exited the labor force, so the U-4 Rate is almost always greater than the U-3 rate.

• U-5: Marginally attached workers (those who have searched for a job in the last 12 months but not in the last four weeks) are included in the denominator, resulting in a bigger percentage compared to the U-4 rate.

• U-6: As the broadest measure of labor underutilization, it includes all unemployed people and those marginally attached to the labor force. The U-6 rate counts individuals working part-time due to the state of the economy (also called involuntary part-time workers) and is expressed as a percentage of the civilian labor force plus the marginally attached.

Spotlight on the U-3 Headline Unemployment Rate and the U-6 Underemployment Rate

The U-3 percentage captures most media headlines and is what economists use to assess the state of the labor situation, but the U-6 rate arguably offers a broader view of the jobs market. 

During boom times, people are often confident enough to look for a job, so the labor force may increase – that might keep the U-3 rate elevated while the U-6 rate falls. Long-lived recessionary periods, however, often result in people giving up hope of finding employment, causing them to exit the labor force. In such a situation, the U-3 rate might remain somewhat low while the U-6 unemployment rate increases. For this reason, the headline rate is commonly criticized for being too restrictive, not taking into account how weak (or strong) the jobs market may be.

The U-6 rate is somewhat less talked about, but it garners attention from analysts and even political figures – it is the so-called “underemployment rate.” The U-6 reading includes discouraged workers who have left the labor force, underemployed workers, as well as the U-3 unemployed group. 

Unemployment In a Macro Context

These two percentages are part of what’s known as labor market indicators. Like with so many other facets of economics and investing, it’s wise to view things from a holistic perspective. Assessing the trend in overall employment growth via the monthly Nonfarm Payrolls report is pivotal when analyzing the U-3 and U-6 rates. 

For example, it’s common for the civilian labor force to grow when the GDP growth rate is above trend (about 3% or higher). People usually feel more upbeat about the prospects of finding new or better work. Hence, previously detached individuals and those underemployed could be on the hunt for full-time employment. The U-3 unemployment rate may not drop very fast, but the broader U-6 rate should decline meaningfully.

On the other hand, sluggish GDP growth or an outright contraction in the overall economy often corresponds with monthly job losses. The weekly Jobless Claims report, published each Thursday morning by the BLS, is seen as a leading economic indicator of the state of the labor market. As initial jobless claims rise, the U-3 unemployment rate is closely monitored for upticks. 

A higher percentage of unemployed people will of course result in a greater U-3 rate in the early innings of a recession. As the economic downturn persists, as was seen during the 2008 Great Recession, the U-3 rate might mask the true damage done to the jobs market since someone not actively seeking work is not counted in the official headline unemployment rate. In such scenarios, the U-6 rate may continue to increase while the U-3 rate holds steady.

The Importance of the Labor Force Participation Rate & Other Important Jobs Market Data Points

Thus, economists and active investors must keep close tabs on changes in the labor force participation rate. In general, it's a positive sign when the participation rate is on the rise along with jobs being added each month. Other important labor market indicators are found in the “Payroll Survey,” including average hourly earnings and hours worked data. The monthly Job Openings and Labor Turnover Survey (JOLTS), and private sector readings from payroll services provider ADP and career-services company Challenger, Gray & Christmas, also provide helpful insights.

The Bottom Line

The unemployment rate and labor force participation rate are two critical measures of the state of the U.S. economy and jobs situation. The U-3 rate captures media headlines, but it is sometimes viewed as too narrow of a gauge of unemployment. The U-6 rate, including underemployed and discouraged job seekers, is seen by some as the true unemployment rate. The labor force participation rate, meanwhile, measures the percentage of working-age Americans actively engaged in the labor market – changes in the rate reflect broader shifts in the overall economy.