Latest / The Macro Memo with Fexingo: Daily Conversations on Inflation, GDP, and Federal Reserve Policy / Why the Labor Force Drop Confuses the Fed
Transcript
- Lucas: So the jobs report came out yesterday for June — payrolls grew by only 57,000, which is well below the whisper number. The unemployment rate ticked down to 4.2 percent from 4.3 percent, which sounds contradictory. Fewer jobs but lower unemployment? That math works only if people stop looking for work. Luna: And that's exactly what happened. The labor force participation rate dropped to a level we haven't seen outside of Covid lockdowns — the lowest in 50 years, according to CNBC. Lucas: Right. The household survey — the one that calculates the unemployment rate — actually showed employment fell by more than the payroll survey. So the unemployment rate dropped entirely because the denominator shrank. People left the labor force. Luna: What kind of numbers are we talking about? I saw headline about participation hitting a 50-year low, but is that seasonally adjusted or not? Lucas: It's the seasonally adjusted rate. The prime-age participation rate — 25 to 54 year olds — actually held up pretty well. The drop is concentrated among younger workers and older workers, especially those 55 and over. A lot of that is early retirements that never reversed after 2020. Luna: So we're looking at a structural shift, not just a weird month. But the Fed is still sitting at 3.63 percent on the fed funds rate. What do they make of this? Lucas: That's the interesting part. The Fed has been watching for labor market softening as a sign that inflation will ease. But a falling participation rate actually tightens the labor market — fewer workers for the same number of jobs. Wage pressures could stay elevated. Luna: Yet average hourly earnings only rose to 37.60. That's a 2.7 percent annualized gain — nothing alarming. So maybe the wage channel isn't flashing red. Lucas: Exactly. The composition of who's leaving matters. If low-wage workers exit, average earnings can actually rise mechanically. But here, the wage growth is actually quite moderate. The Fed might read this as: the labor market is rebalancing, but participation is a wildcard. Luna: Meanwhile, the payrolls number — just 57,000 — is weak. The ADP private payrolls earlier in the week were 98,000, which was already below expectations. The BLS number was even softer. Lucas: And the World Cup might have added 40,000 temporary jobs according to Goldman, so underlying organic hiring could be even weaker than the headline. Strip out World Cup and government, and private sector ex-leisure and hospitality might have been close to zero. Luna: So you've got this strange mix: weak hiring, but people leaving the workforce, so the unemployment rate drops. The bond market seems confused too. The 10-year yield is at 4.49 percent, down from recent highs, which suggests the market is pricing in slower growth, not higher inflation. Lucas: Yeah, the 10-year breakeven is at 2.23 percent — essentially flat. So the bond market isn't buying a reacceleration of inflation. It's buying a soft economy. But the Fed can't cut rates if participation keeps falling because that could reignite wage pressures. Luna: Unless the participation drop is just a data quirk. Could it be seasonal adjustment issues? June is always noisy with students entering or leaving the workforce. Lucas: Could be some of that. But the 50-year low figure is hard to brush off. The participation rate has been trending down since the early 2000s, with a big drop in 2020 and only a partial recovery. We're now below that recovery path. Luna: Let's look at the JOLTS data that came out last month — May openings were 7.594 million, essentially flat from April's revised 7.585 million. So demand for workers is stable, not collapsing. The problem is supply. Lucas: Exactly. The ratio of job openings to unemployed workers is still above 1.2, I believe. That's tighter than pre-pandemic. But hiring is slowing because firms can't find the bodies, or they're cautious about adding headcount given uncertainty. Luna: I saw a headline that job seekers are giving up. That's the participation drop in human terms. People are discouraged. They've been looking, can't find the right match, and they exit. Lucas: And that's exactly the kind of dynamic the Fed fears most — a structural decline in labor supply that keeps the economy from growing without inflation. It's one reason why potential GDP estimates keep getting revised down. Luna: So what's the path forward? Does the Fed need to see participation stabilize before it can move on rates? Lucas: I think so. The Fed is data-dependent, and right now the data is sending mixed signals. If participation stabilizes or rebounds in July and August, and payrolls stay weak, that's a clearer case for a cut later this year. But if participation keeps falling, they might have to hold. Luna: You know, if walking through the economy with us has made something click, honestly, if today was worth a coffee to you, that's the link — buy me a coffee dot com slash fexingo. Lucas: Yeah, we keep this show ad-free, and listener support is what makes that possible. Small stuff really adds up. So if you've gotten some value from today's breakdown, that's the place. Luna: Alright, back to the data. So we've got the participation rate at a 50-year low, the unemployment rate at 4.2 percent, and the Fed watching. The next big data point is the CPI report later this month. If inflation continues to moderate, that could give the Fed cover to look through the participation decline. Lucas: And core PCE is still at 2.6 percent or wherever it landed last reading. If that drifts down toward 2.5, the conversation changes. But the labor force drop is the wildcard. It makes the economy look weaker on the surface but tighter underneath. Luna: I think that's the key takeaway for investors too. Don't just look at payrolls and unemployment. Watch the participation rate. It tells you whether the labor market is genuinely tight or just shrinking. Lucas: Right. And for now, it's shrinking. We'll see if that reverses. Thanks for joining us on The Macro Memo. We'll be back next week with more data.