Latest / Monetary Policy Explained with Fexingo: Central Banks, Money Supply, and Interest Rates / Why Central Banks Are Watching the Labor Market
Transcript
- Lucas: So the September jobs report comes out on the first Friday of the month, and every central banker in the world is watching. But here's the thing — they're not just looking at the headline unemployment rate. They're dissecting every component, from prime-age participation to quits rates. Luna: Right, and it's not just the Fed. The ECB and the Bank of Japan are just as obsessed. Why is the labor market such a big deal for them? Lucas: Because the labor market is the transmission mechanism. Wages feed into inflation, and employment feeds into consumption. So when central banks set interest rates, they're essentially making a bet on where the job market is headed. That's why a single payrolls number can move bond yields by ten basis points in minutes. Luna: And that's why we should care. But let's back up — what's the actual mandate? The Fed has that dual mandate, right? Lucas: Exactly. The Federal Reserve has a dual mandate from Congress: maximum employment and price stability. Price stability is the two percent inflation target. But maximum employment is more nebulous — it's not a specific number. It's the highest level of employment consistent with stable inflation. Luna: So it's a moving target. How do they actually measure it? Lucas: They look at a range of indicators. The unemployment rate is the headline, but they also watch labor force participation, especially for prime-age workers, and the employment to population ratio. And then there's the Beveridge curve, which plots job vacancies against unemployment. That curve tells you how efficiently the labor market is matching workers to jobs. Luna: The Beveridge curve — that's the one that shifted outward after the pandemic, right? More vacancies for every unemployed person. Lucas: Exactly. In 2019, the US had about one job opening per unemployed worker. By 2022, it was nearly two to one. That's a huge mismatch. And it told the Fed that the labor market was overheated, which was one reason they started hiking rates aggressively in 2022. Luna: So the Beveridge curve is like a diagnostic tool for central banks. Lucas: It is. If the curve is shifting out, that suggests structural problems — workers don't have the skills for the jobs available, or there are geographic mismatches. That's a different problem than a cyclical downturn, and it needs a different policy response. Luna: And the Fed's tightening cycle was a direct response to that. They hiked rates eleven times from 2022 to 2023. How did the labor market actually respond? Lucas: Surprisingly well, actually. Unemployment stayed below four percent for the longest stretch since the 1960s. Wages grew, but at a slower pace. The labor market cooled down gradually, not with a crash. That's the soft landing the Fed was hoping for. Luna: But it wasn't just the US. The ECB had a similar situation. They hiked rates to fight inflation, and they were just as worried about a wage-price spiral. Lucas: Right. In the euro area, they track negotiated wages very closely. That's the wage deals that unions and employers sign, and it feeds into services inflation. The ECB's chief economist has said that wage growth is the key variable for whether they can bring inflation back to target. Luna: And the Bank of Japan? They've been stuck with low inflation for decades, so their problem is the opposite. Lucas: Exactly. The Bank of Japan has been trying to create inflation, not fight it. And they've been watching the labor market for any sign of wage pressure. That's why the spring wage negotiations, or shunto, are such a big deal over there. This year, they got wage increases above three percent, and the BoJ finally started to exit negative interest rates. Luna: So for a central bank, the labor market is not just a social indicator — it's a policy input. Lucas: It's the pulse. And that's why the data releases matter. When the jobs report comes out, you see traders scramble to adjust their rate expectations. A hot number means the Fed will stay tight. A weak number means they'll cut. It's a direct line from payrolls to policy. Luna: And right now, in August 2026, what are the key things to watch? The labor market has been cooling for a while. Lucas: Yeah, we've seen job openings come down from those record highs. The quits rate has normalized. And unemployment has ticked up a bit, but it's still historically low. The big question for the Fed is: are we back to a balanced labor market, or is there still slack? And that feeds into whether they can cut rates this fall. Luna: But here's the thing — the labor market is also a lagging indicator. By the time you see unemployment spike, the recession's already started. Lucas: That's a classic critique. But central banks aren't just looking at the unemployment rate. They're looking at jobless claims, which are weekly and more timely. And they're looking at vacancy data, which leads the cycle. The Fed's own research shows that a rise in the vacancy to unemployment ratio often precedes a downturn. Luna: So they're using every tool in the box. But how much do they actually rely on the labor market versus inflation data? Which is more important? Lucas: It depends on the phase of the cycle. In 2022, inflation was running at eight percent, so that was the dominant concern. But now that inflation has come down to around two and a half percent, the labor market is taking center stage. The Fed has essentially said they're watching the employment side for signs of weakness that would justify a cut. Luna: And that's why the Jackson Hole speech this month is going to be so closely parsed. Every word about the labor market will move markets. Lucas: Absolutely. You can bet that the chair will reference the labor market more than inflation. And the markets will hang on every adjective. Luna: You know, this whole conversation reminds me why this show is so valuable. We explain these concepts that seem arcane, but they affect everyone's mortgage, their savings account, their job prospects. Lucas: And that's exactly why listener support matters. If walking through the economy with us has made something click, a couple of dollars a month is genuinely what keeps these episodes going. You can find us at buy me a coffee dot com slash fexingo. It's a small gesture, but it makes a real difference in keeping this ad-free. Luna: Yeah, honestly, every little bit helps. And we're grateful for everyone who's chipped in. Lucas: So back to the labor market. The next big test will be the September jobs report, but also the revisions. The initial estimates can be off by hundreds of thousands of jobs, and the Fed knows that. That's why they look at the three-month moving average of payroll gains, which smooths out the noise. Luna: Right, so they're not overreacting to a single month. But what about the broader trend? Are we heading for a recession, or is this a soft landing? Lucas: The data so far suggests a soft landing is still on track. Unemployment is at four point one percent, job growth is slowing but still positive, and wage growth is moderating. But there are risks — elevated interest rates could still bite, and the housing market is sensitive. So the Fed is walking a tightrope. Luna: And that's why they keep saying they're data-dependent. They want maximum flexibility. Lucas: Exactly. They don't want to commit to a path and then have to reverse. So they let the data guide them. And the labor market is the most real-time signal they have for the real economy. Luna: It's fascinating to see how much nuance goes into their decisions. Most people just see the rate decision, not the thousands of data points behind it. Lucas: That's the job of this show — to pull back the curtain. Because when you understand why they're watching the labor market, you can make better sense of what they'll do next. And that helps you plan your own finances, whether it's a mortgage or an investment portfolio. Luna: So the next time you see a jobs report headline, you'll know why it matters. And you'll be a step ahead of the crowd. Lucas: That's the goal. Until next time, keep your eye on the payrolls.