Latest / The Federal Reserve Podcast with Fexingo: Interest Rates, FOMC Meetings, and Monetary Policy / How Falling Participation Forces the Feds Hand
Transcript
- Lucas: So the June jobs report landed last Thursday — payrolls growth of just 57,000, unemployment rate ticking up to 4.2 percent. Markets barely flinched. The S&P 500 is up about two percent over the past five days. Luna: Right, because the headline was weak enough to keep rate-cut hopes alive but not so weak that it screamed recession. At least that's the read. Lucas: Exactly. But there's a number in that report that I think deserves more attention than payrolls or the unemployment rate. Labor force participation fell to sixty-two point four percent. That's the lowest it's been in fifty years, if you set aside the pandemic lockdown period. Luna: And we've talked about participation before — episodes 90 through 93 were all about why the Fed cares about people giving up on jobs. But this fresh drop changes the calculus, doesn't it? Lucas: It does, because the participation rate isn't just a labor market statistic. It's a structural input into the Fed's inflation model. When people leave the workforce, the supply of available workers shrinks. Employers have to compete more aggressively for the remaining pool, which pushes up wages. Luna: And higher wages, if they're not matched by productivity gains, feed into services inflation — which is exactly what the Fed is watching. Core PCE is still running at two point six percent year-over-year as of the May reading. Lucas: Right, and that is well above the two percent target. The traditional story is that a cooling labor market — weaker payrolls, higher unemployment — should reduce wage pressure. But if the labor force is shrinking, you can have weak payrolls and still have a tight labor market from the supply side. Luna: So the participation drop basically breaks the standard relationship between job growth and wage inflation. That's a headache for the FOMC. Lucas: It's a big headache. Because now the Fed faces a real dilemma. If they cut rates to support the economy — and markets are pricing in a cut later this year — they risk reigniting demand for services before the supply of workers recovers. That could keep core PCE sticky above target for another year. Luna: But if they hold rates steady, or even raise, they risk crushing the demand side unnecessarily, since the tightness is coming from a supply problem, not excess demand. Lucas: Exactly. This is the supply-side inflation that the Fed has been wrestling with since 2021, but it's now taking a new form. Earlier it was supply chains and energy. Now it's labor supply. And the participation rate isn't something the Fed can fix with interest rates. Luna: What's driving the latest drop? The headlines point to a couple of factors. The CNBC article that ran Thursday specifically mentioned 'job seekers giving up,' and tied it to the participation rate falling to its lowest in fifty years outside of COVID. Lucas: Yeah, and there's a demographic layer too. The aging of the baby boom generation has been pulling participation down for years. But the recent acceleration — the drop from about sixty-three percent in early 2023 to sixty-two point four now — that's not just demographics. That's discouraged workers leaving the job search entirely. Luna: And those are the people the Fed would normally hope to draw back into the labor force as the economy strengthens. But if they've left permanently — retired early, or shifted to disability, or just given up — then the supply of workers is structurally lower. Lucas: That's the critical question: how much of this drop is cyclical and how much is structural. If it's mostly structural, then the Fed has to accept that the economy can't grow as fast without generating inflation. The neutral rate — R-star — might be higher than anyone thought. And that means rates may need to stay higher for longer. Luna: The ten-year yield is at four point four eight percent this morning, which is actually down a bit from recent highs. The market seems to be betting that the Fed will cut despite the participation issue. But that might be wishful thinking. Lucas: It might be. Look at the fed funds rate — it's been flat at three point six three percent since June. Interest on reserve balances is three point six five. The Fed is clearly in a holding pattern. But if participation stays this low, and wage growth remains elevated — average hourly earnings were up four point two percent year-over-year in June — then the case for cutting gets weaker, not stronger. Luna: So the participation data essentially tells the Fed: 'You can't cut without risking a reacceleration of inflation.' But the payrolls number tells a different story: 'The labor market is slowing, and if you don't cut, you might tip it into recession.' Lucas: Right. And that's why I think this is the most important economic number for the next few months. Not the monthly payrolls headline, not even CPI — but the participation rate. If it stabilizes or ticks back up, the Fed has room to cut. If it keeps falling, they're stuck. Luna: One thing that might help is immigration. The labor force has been boosted over the past couple of years by an increase in foreign-born workers. If that trend continues, it could offset some of the native-born decline. Lucas: True. The foreign-born labor force participation rate is actually higher than the native-born rate, and immigration has been a significant factor in keeping the overall participation rate from falling even further. But that's a politically charged variable, and it's not something the Fed can count on or control. Luna: So we're back to the same conclusion: the Fed's job just got harder. And the data they're looking at is sending mixed signals. Lucas: It really is. And I think for listeners trying to make sense of where rates are headed, the participation rate is the single best leading indicator to watch. If you see it stabilize in the next few months, the odds of a cut go up. If it drops further, expect the Fed to hold firm. Luna: And on that note — if you find these conversations helpful, and you want to support the show staying independent and ad-free, a couple of dollars a month is genuinely what keeps these going. Buy me a coffee dot com slash fexingo, if you've gotten something out of them. Lucas: Yeah, absolutely. It makes a real difference, and we appreciate everyone who chips in. Luna: So back to participation — one more thing. The JOLTS data for May comes out this week. That will give us another look at quits and openings, which are also key for wage pressure. Lucas: Good point. JOLTS, along with the next CPI print on July 15, will be the next big tests for the narrative we've been building. If job openings fall sharply and participation stays flat, that might give the Fed cover to cut. But if openings stay elevated and participation drops again, they're stuck. Luna: So the bottom line for this episode: the labor force participation rate is the hidden variable that could determine the pace of rate cuts — or whether they happen at all. Lucas: Exactly. And it's a variable the Fed can't directly influence. That makes the next few months particularly interesting. We'll be watching closely.