Latest / The Federal Reserve Podcast with Fexingo: Interest Rates, FOMC Meetings, and Monetary Policy / How a Falling Participation Rate Confuses the Fed
Transcript
- Lucas: Luna, I keep coming back to one number from the June jobs report, and it's not the headline payrolls miss or the unemployment rate ticking up to 4.2 percent. Luna: Let me guess — the participation rate. Lucas: Exactly. The labor force participation rate fell to its lowest level in 50 years, outside of the pandemic period. That's a huge signal, and I think the market is underappreciating what it means for the Fed. Luna: So walk me through it. Why does the participation rate matter more than the unemployment rate right now? Lucas: Because the unemployment rate can be artificially low when people stop looking for work. If you're not in the labor force, you're not counted as unemployed. So a falling participation rate can mask real weakness in the job market. Luna: Right. And we saw payrolls growth of just 57,000 in June. That's well below what's needed to keep up with population growth. Lucas: Exactly. The Fed looks at the employment to population ratio and the participation rate to get a fuller picture. When participation drops, it suggests that workers are becoming discouraged — they don't think they can find a job, so they stop trying. Luna: And that's different from people choosing to retire early or stay home with kids. This is about people giving up. Lucas: Yes. And the Fed cares because a shrinking labor force puts upward pressure on wages — fewer available workers means employers have to compete harder. But if demand for workers is also cooling, you get a confusing mix. Luna: So the Fed might see wage growth staying elevated even as the economy slows. That's the stagflationary scenario they're trying to avoid. Lucas: Precisely. And look at the inflation data. Core PCE is still running above 3 percent year-over-year. The Fed's preferred gauge hasn't come down as fast as they hoped. Luna: So a tight labor market, even if partly due to people dropping out, could keep services inflation sticky. Lucas: That's the concern. The June jobs report showed payrolls slowing, but wages still rose at a decent clip. If participation stays low, the Fed may have to keep rates higher for longer to cool the labor market enough to bring inflation down. Luna: But higher rates also risk further depressing participation — people who are on the sidelines might see fewer job openings and decide it's not worth looking. Lucas: That's the vicious cycle. And it's why the Fed is in a tough spot. They've held rates steady at the last few meetings, with the fed funds rate at 3.63 percent. But if the economy is weakening and inflation is still above target, they have limited room to cut. Luna: Especially with the 10-year Treasury yield at 4.49 percent. The yield curve is still inverted, which is a classic recession signal. Lucas: Right. And the inversion has been persistent. Longer-term rates are higher than short-term rates, which suggests the bond market expects the economy to slow. But the Fed is focused on inflation, so they're reluctant to ease. Luna: So what would change the Fed's mind? Does the participation rate itself move the needle? Lucas: I think it should. A declining participation rate is not just a statistical quirk — it's a structural shift. If more workers are giving up, the economy's potential growth rate is lower. That means the Fed might need to accept a higher natural rate of unemployment to keep inflation in check. Luna: That's a big deal. It would mean the Fed's estimates of the neutral rate of interest, or r-star, might be wrong. Lucas: Exactly. And we've seen Fed officials start to talk about r-star uncertainty more. But they haven't really addressed the participation issue head-on in recent speeches. Luna: Maybe they're waiting for more data. But the trend is clear — the participation rate has been trending down for years, and the pandemic accelerated it. Lucas: And it's not just older workers retiring. Prime-age participation, for people 25 to 54, is still below pre-pandemic levels. That's the group you'd expect to be working. Luna: So what's the takeaway for the next FOMC meeting? Do you think they'll cut rates in July? Lucas: I doubt it. The data is too mixed. Payrolls are slowing, but core PCE is still at 3.2 percent year-over-year. The Fed will want to see a few more months of inflation moderation before they pull the trigger. Luna: Especially with the 10-year breakeven inflation rate at 2.23 percent. That's close to target, but not convincingly below. Lucas: Yeah, and the Fed has been burned by premature easing before. They're going to be cautious. Luna: Speaking of being cautious — you know, if today's episode helped you make sense of the participation rate and why it matters, that's exactly the kind of thing we try to do here. Lucas: Absolutely. And if you find this useful, the way we keep the podcast ad-free is through listener support. You can buy us a coffee, literally, at buy me a coffee dot com slash fexingo. Luna: It's a small gesture that helps us keep doing deep dives like this. No pressure, just if you've gotten something out of it. Lucas: Right. So back to the Fed — I think the participation rate is the single most underappreciated data point for the second half of 2026. Luna: And we'll be watching to see if any Fed officials start mentioning it in their speeches. Lucas: Exactly. If they do, that's a signal that the conversation is shifting. Luna: Good episode. Thanks, Lucas. Lucas: Thanks, Luna.