Latest / The Federal Reserve Podcast with Fexingo: Interest Rates, FOMC Meetings, and Monetary Policy / Why the Fed Cares About People Giving Up on Jobs
Transcript
- Lucas: So the June jobs report lands Thursday — 57,000 new payrolls, unemployment ticks up to 4.2 percent — and every headline leads with the miss. But I think the number that should actually keep Fed officials up at night is the one buried in the household survey. Luna: The participation rate. Lucas: Exactly. The labor force participation rate fell to its lowest level in fifty years outside of the COVID period. That's not a blip. That's a structural shift in how many people are even trying to find work. Luna: And it changes how you read the unemployment rate too, right? If people stop looking, they're not counted as unemployed. So 4.2 percent looks okay, but it's masking a lot of discouraged workers. Lucas: Right. The unemployment rate can stay low or even fall while the actual employment situation deteriorates, because the denominator shrinks. And for the Fed, that's a problem for their inflation model. Luna: Because fewer workers means less capacity to produce goods and services without pushing up wages and prices. Lucas: Exactly. You've got core PCE still running at an annualized rate above 3 percent — the May reading was 130.1 on the index, up from 129.67. That's not falling fast enough. And if the labor supply is shrinking, then even moderate demand can keep inflation sticky. Luna: So the Fed's preference cascade idea — that inflation gets transmitted through expectations and wage-setting — that only works if there are workers to set wages. Lucas: Right. And you're seeing that tension in the bond market. The ten-year breakeven inflation rate is at 2.23 percent. That's not signaling a collapse in inflation expectations. It's signaling that the market thinks the Fed is going to have a hard time getting back to 2 percent. Luna: And the Fed funds rate is sitting at 3.63 percent. They've been on hold for a while. Does a participation rate like this give them cover to stay on hold longer? Lucas: I think it does. Because if you're Chair Powell, you can say: we don't need to cut because the economy isn't collapsing — unemployment is low by historical standards. But you also don't need to hike because the labor market is clearly softening. The participation drop becomes a reason to wait and see. Luna: The risk is that waiting too long means the supply side never recovers. People who've been out of work for a year or more — their skills atrophy, their networks shrink. They may never come back. Lucas: That's the hysteresis argument. And there's some evidence it's already happening. The prime-age participation rate — people 25 to 54 — that's actually held up better. It's the younger and older cohorts that are dropping out. But once you lose that attachment, it's hard to rebuild. Luna: So what's the Fed's real reaction function here? Because they've been data dependent, but the data keeps sending mixed signals. Lucas: I think the key is that they're increasingly looking at the composition of the labor market, not just the top-line numbers. The July 2 report showed 57,000 jobs — that's below the 100,000 needed to keep up with population growth. But the participation rate tells you why: it's not just that hiring slowed, it's that the pool of available workers is shrinking. Luna: And that makes the inflation problem harder to solve without higher unemployment. Lucas: Exactly. The old trade-off — you cool demand, unemployment rises, inflation falls — that assumes the supply side is fixed. But if the supply side is actively contracting, you need more demand destruction to get the same inflation result. And that's a painful path. Luna: Have any Fed officials talked about this explicitly? I saw some speeches but nothing that really connected the dots. Lucas: Not directly. But you can read it in the minutes. The preference cascade framework they've been developing — it's basically a supply-side story. If people expect inflation, they demand higher wages, firms raise prices, and it becomes self-fulfilling. But that cascade depends on workers having bargaining power. A shrinking labor force gives them that power. Luna: So the participation rate is almost a leading indicator for wage pressure. Lucas: I'd say it's a co-incident indicator. Look at the Atlanta wage tracker — it's still running around 5 percent year-over-year. That's not consistent with 2 percent inflation. And the participation rate explains why: there's just less slack in the labor market than the unemployment rate suggests. Luna: One thing I keep thinking about — the ten-year breakeven at 2.23. That's not panic. That's the market saying 'we think the Fed will tolerate above-target inflation for a while.' Lucas: And that tolerance might be exactly what the participation rate forces on them. If they try to crush inflation back to 2 percent by raising rates, they'd need to break the labor market even further. And with participation already at fifty-year lows, that's a hard sell politically and economically. Luna: So the path of least resistance is to let inflation run a little hot while hoping the supply side heals. Lucas: Exactly. And that's basically where they are. The fed funds rate at 3.63, the ten-year at 4.48 — that's not a restrictive stance if you believe the neutral rate has moved up. And the participation rate is one reason to believe it has. Luna: You know, this is the kind of conversation that really benefits from being able to go deep without rushing. Quick honest thing — a handful of listeners chip in monthly through buy me a coffee dot com slash fexingo, and that's literally what funds making this many of these. No ads, no sponsors, just people who find this useful. Lucas: Yeah, it's a small group but it keeps us independent. And we get to pick the one number that actually matters each week instead of chasing headlines. Luna: Exactly. Anyway — back to the participation story. You mentioned hysteresis. Is there any policy lever the Fed has to reverse that? Lucas: Not directly. Monetary policy can't retrain workers or build childcare infrastructure. That's fiscal. But the Fed can influence the timeline. If they cut rates too soon, they risk reigniting inflation and then having to raise again, which would be even more disruptive. If they wait, they risk letting hysteresis set in permanently. Luna: So they're stuck between a rock and a hard place. Lucas: They are. And the participation rate is the rock. The good news is that the ten-year breakeven isn't spiking — 2.23 is elevated but not alarming. That suggests the market trusts the Fed to eventually get inflation under control, just slowly. Luna: So the bottom line: the June jobs report was weak, but the real story is that fewer people are even trying to get a job. And that makes the Fed's job harder, not easier. Lucas: Exactly. And it means that even if the next few payrolls reports come in soft, the Fed might not cut as quickly as the market hopes, because they're watching the same participation rate we are. Luna: Which brings us back to the ten-year yield at 4.48. The bond market is already pricing in that patience. Lucas: Right. So for the next FOMC meeting, watch the participation rate more than the unemployment rate. If it stays at these lows, the Fed stays on hold.