Latest / The Federal Reserve Podcast with Fexingo: Interest Rates, FOMC Meetings, and Monetary Policy / How the Fed Reads the Rising Participation Rate
Transcript
- Lucas: So the labor force participation rate is finally moving in the other direction. After years of grinding lower, it ticked up in June to sixty-two point six percent — still historically low outside of the pandemic, but the direction matters more than the level here. Luna: Wait, you're talking about the headline number from the jobs report a week and a half ago? The one where payrolls came in at just fifty-seven thousand? Lucas: Exactly that report. And on its face, a payrolls miss like that screams 'economy slowing, Fed should cut.' But the participation rate increase complicates the picture. It tells us more people are entering or re-entering the labor force — which is a supply-side positive for the economy. Luna: Okay, so more workers means more supply, which should cool wage growth and inflation — that sounds like good news for the Fed. Where's the complication? Lucas: The complication is that those new entrants don't instantly get jobs. The unemployment rate ticked up to four point two percent from four point one. So you've got more people looking, but not enough jobs being created. That's a sign the labor market is loosening, but not because demand collapsed — because supply came back. Luna: Right, and the Fed has been hoping for exactly that: labor supply returning to ease wage pressures without having to crush demand. So is this a win? Lucas: It is — if it continues. But here's the thing the Fed is watching closely: the participation rate for prime-age workers, twenty-five to fifty-four, is already above pre-pandemic levels. The recent increase is coming from older workers and younger people who had dropped out. That group tends to have lower attachment to the workforce. Luna: Meaning they might drop back out if the job market softens. So the Fed can't count on this supply boost persisting. Lucas: Exactly. And that's why Chair Powell and others have been careful not to declare victory on the labor supply front. In the June press conference, he specifically noted that the participation rate has been 'moving sideways' and that the Fed needs to see sustained improvement. Luna: I remember that. He also mentioned that immigration has been a factor in boosting labor supply, but that's hard to project going forward. Lucas: Right. So the Fed is in a tricky spot. If participation keeps rising, it could allow the economy to run a bit hotter without generating inflation — which would let them hold rates steady or even cut. But if participation stalls and payrolls stay weak, then the economy is generating fewer jobs with a stable or shrinking workforce, which is a classic recession signal. Luna: And the bond market seems to be pricing that risk in. The ten-year yield has been moving around a lot — it's at four point five four percent today, up about twelve basis points in the last week. That's not a market screaming 'cut soon.' Lucas: No, it's not. And the two-year yield is at three point six eight, so the curve is still inverted. The market is pricing in maybe one cut by year-end, but it's not confident. The Fed's own dot plot from June showed just one cut in 2026, and that was before this jobs report. Luna: So the rising participation rate — if it's real — could be the thing that gives the Fed cover to cut. But they need to see it in the data for a few more months. Lucas: Exactly. And they'll also be watching the quits rate, which has fallen back to pre-pandemic levels. Fewer people quitting means less upward pressure on wages. The Fed's preferred measure, the Employment Cost Index, has been moderating. Luna: But inflation is still sticky. Core PCE is at two point seven percent, well above the Fed's two percent target. And the May CPI data showed core services inflation still running hot. Lucas: That's the rub. The Fed needs to see both labor supply improve and inflation come down. The participation rate uptick is a promising data point, but it's one data point. And historically, when participation rises during a late-cycle slowdown, it often reverses. Luna: So you're saying the Fed is probably in 'wait and see' mode for at least the next two meetings. Lucas: That's my read. The July meeting is too soon — that's in two weeks. They'll likely hold steady and wait for the August jobs report and the July CPI print before signaling anything. The question is whether the participation rate can sustain its increase. Luna: Alright, let me push back a little. If participation is rising and payrolls are weak, doesn't that just mean the economy is absorbing workers more slowly? That's not necessarily bad — it could be a rebalancing. Lucas: It could be. And that's the optimistic interpretation. But the Fed has to worry about the downside scenario where participation rises because people need income — they're running out of savings — not because they see great job opportunities. That kind of participation increase doesn't boost productivity the same way. Luna: Good point. The quality of the labor supply matters, not just the quantity. Lucas: And that brings us back to the composition issue. The prime-age participation rate is already above where it was in 2019. The gains now are coming from older workers, who may be working part-time or in lower-skilled roles, and from young people who might have been in school or training. Those groups are more sensitive to economic conditions. Luna: So the Fed is basically hoping that the participation rate increase is structural, not cyclical. Lucas: Exactly. If it's structural — like more women in their thirties and forties joining the workforce, or better childcare access — then it's a lasting supply boost. If it's cyclical — people coming back because they have to — then it could reverse quickly when the next downturn hits. Luna: And the data on that is mixed. The prime-age female participation rate has been rising steadily, which looks structural. But the overall rate is still well below pre-2008 levels. Lucas: Right. So the Fed is watching several sub-categories. They're also looking at the hiring rate and the job openings rate, which have both come down from their peaks. The Beveridge curve — the relationship between vacancies and unemployment — is normalizing. That's a good sign. Luna: Okay, so let's tie this back to the rate path. If participation continues to rise and inflation drifts lower, the Fed could cut in September or December. If participation stalls and inflation stays sticky, they might hold through year-end. Lucas: That's the range of outcomes. And the market is pricing in roughly a fifty-fifty chance of a cut by September. But I think the Fed wants to see at least two more months of data before committing. Luna: You know, listening to you walk through all this, it really makes you appreciate how many variables the Fed has to weigh. And it's not just the data — it's the interpretation of the data. Lucas: Absolutely. And that's why we do this show. If walking through the economy with us has made something click for you, honestly, if today was worth a coffee to you, that's the link — buy me a coffee dot com slash fexingo. Luna: Yeah, we keep this podcast ad-free and independent because of listener support. Every little bit helps us keep digging into the details. Lucas: So back to the participation rate — one more angle I want to hit. The Fed's own research suggests that demographic trends alone will push the participation rate down over the next decade as baby boomers retire. So any cyclical increase we see now is a temporary gift. The Fed cannot assume this supply boost will last. Luna: That's sobering. So even if participation rises for a few months, the long-term trend is still lower. That means the Fed may have to accept a lower neutral rate of interest — r-star — in the future. Lucas: Exactly. And that's a whole other conversation. But for now, the key takeaway is: don't overinterpret one month of rising participation. Watch the trend, watch the composition, and watch what the Fed says at the July meeting. Luna: And we'll be watching right along with them. Thanks, Lucas. Lucas: Thanks, Luna. Until next time.