Latest / The Macro Memo with Fexingo: Daily Conversations on Inflation, GDP, and Federal Reserve Policy / Why the Labor Force Drop Confuses the Fed More Than Ever
Transcript
- Lucas: So the headline from Thursday's jobs report was pretty stark — payrolls grew by just 57,000 in June, which is well below the pace we'd gotten used to. But the number that's really sticking with me is the labor force participation rate. Luna: Because it dropped again, right? I saw it hit what CNBC called the lowest in 50 years outside of COVID. Lucas: Exactly. It fell to something like 62.2 percent or so — and that's a level we haven't seen since the 1970s, basically. And the weird thing is, the unemployment rate actually ticked down to 4.2 percent from 4.3. So we have fewer people in the labor force, but the people who are in it seem to be finding jobs. Luna: So fewer people are looking, but those who are looking are finding work. That's not a tight labor market in the traditional sense — it's a shrinking one. Lucas: Right. And that's what makes this so confusing for the Fed. Because normally, a tight labor market means more people are employed, wages go up, and that feeds into inflation. But here, the labor force is contracting, which could mean fewer workers available, pushing wages up via scarcity — but we're not seeing the broad-based demand-pull inflation you'd expect. Luna: Although wage growth is still positive. Average hourly earnings are up to $37.60, that's a 2.4 percent annualized increase from last month's data. Lucas: Yeah, it's creeping up. But here's the thing — if the participation rate is falling because workers are retiring, or leaving due to health or family reasons, that's a structural shift. The Fed can't fix that with interest rates. It's not cyclical. Luna: So the Fed is stuck looking at a labor market that's sending mixed signals — payrolls are weak, participation is falling, but the unemployment rate is low and wages are rising. What do they prioritize? Lucas: That's the trillion-dollar question. And I think the bond market is giving us a clue. The ten-year yield is at 4.48 percent, down a bit from recent highs, and the two-year is at 3.67. That's a pretty flat curve, which suggests the market thinks the Fed will have to cut eventually, but not because the economy is booming — more because growth is slowing and inflation is still sticky. Luna: Core PCE is still above 3 percent, core CPI at 336 — inflation hasn't gone away. So the Fed can't cut aggressively without risking a reacceleration. Lucas: Right. And this is where the participation rate drop becomes a real headache. Because if fewer people are working, that could eventually slow the economy enough that the Fed might need to ease — but if it's structural, then cutting rates might not bring workers back, it could just reignite inflation in other areas. Luna: It's like they're damned if they do, damned if they don't. And the data we have — JOLTS job openings are still around 7.6 million, which is high, but not as high as a year ago. So demand for labor is cooling, but supply is cooling faster. Lucas: Exactly. And that's the subtle but crucial point. The ratio of job openings to unemployed workers is still above one, but it's coming down. If the participation rate keeps falling, that ratio could stay elevated even as hiring slows. And the Fed watches that ratio closely. Luna: So for listeners, what's the one concrete takeaway from this episode? If you're watching the economy, what should you look for? Lucas: I'd say watch the prime-age participation rate — workers aged 25 to 54. That's less affected by retirements and schooling. If that starts to fall, then we have a real problem. If it holds steady or rises, then the headline drop is mostly demographics and the Fed can look through it. Luna: And that data comes out with the monthly jobs report, so we'll get an update in a few weeks. But in the meantime, the Fed's next meeting is end of July — what are the odds they move? Lucas: Near zero. The Fed funds rate is at 3.63 percent, and the market is pricing in a cut maybe in September or December. But with this labor force drop, they'll want more data before making any move. They're data-dependent, and this data is confusing. Luna: Speaking of data — one thing that helps us keep digging into these numbers is listener support. A couple of dollars a month is genuinely what keeps this show ad-free and independent. Lucas: Yeah, it's a small thing that makes a big difference. If walking through the economy with us has made something click, you can help at buy me a coffee dot com slash fexingo. Seriously, it's that simple. Luna: And we're back to the macro picture. So if the participation rate is dropping structurally, what does that mean for potential GDP growth? Lucas: It's a drag. Real GDP growth annualized was 2.1 percent in the first quarter, up from a paltry 0.5 in Q4 of last year. But if the labor force isn't growing, potential output can't grow as fast either. We might be looking at a lower speed limit for the economy. Luna: So even if productivity improves, the shrinking workforce caps how fast we can expand without overheating. That's a big deal for long-term investors. Lucas: Absolutely. And it's one reason why the equity market has been rallying — the S&P 500 at 7483, the Dow at 52900 — despite mixed economic data. Markets are pricing in a 'softish' landing, not a recession, but they're also betting the Fed will ease eventually. Luna: But if the Fed can't ease because of sticky inflation, and the labor force keeps shrinking, that soft landing could turn into something else. Lucas: Right. And that's the tension we'll be watching all summer. The next jobs report, the next CPI print, and especially the participation rate for prime-age workers. Luna: Well, we'll keep tracking it. Thanks for hanging with us on The Macro Memo. Lucas: Talk to you next time.