Latest / The Federal Reserve Podcast with Fexingo: Interest Rates, FOMC Meetings, and Monetary Policy / Why Payrolls of 57000 Change the Feds Calculus
Transcript
- Lucas: Luna, the headline number from last Thursday's jobs report — 57,000 new payrolls in June — that is well below what most forecasters were expecting. And the unemployment rate ticked up to 4.2 percent. So the question that I keep hearing from listeners is: does this finally change the Fed's calculus? Luna: It's interesting because the Fed has been saying they need to see more evidence that the labor market is cooling before they can feel confident about cutting rates. And then June delivers what looks like a pretty clear cooling signal. Lucas: Right. And it's not just the headline. The prior two months were revised down by a combined 111,000 jobs. So the three-month average is now running at about 140,000, which is down from over 200,000 earlier this year. That's a meaningful slowdown. Luna: And yet the Fed Funds rate is still sitting at 3.63 percent. The effective rate hasn't moved since June. So what's the hold-up? Lucas: The hold-up is inflation — specifically core PCE, which came in at 130.1 in May, up from 129.67. That's still running above the Fed's 2 percent target on a year-over-year basis. And the 10-year breakeven inflation rate is at 2.23 percent, which suggests the bond market doesn't think inflation is vanquished yet. Luna: So you've got a labor market that's clearly softening but inflation that's still sticky. That's the classic central banker's dilemma. Lucas: Exactly. And the piece that I think isn't getting enough attention is the labor force participation rate. It fell again in June. It's now at the lowest level outside of the pandemic era in 50 years. That number — the participation rate — it's not just a statistic. It tells you that people are giving up on looking for work. Luna: Which actually makes the unemployment rate look better than it really is. If people drop out of the labor force, they're no longer counted as unemployed. So a 4.2 percent unemployment rate might be masking a weaker underlying reality. Lucas: That's exactly the point. The Fed has a dual mandate: maximum employment and stable prices. If participation keeps falling, maximum employment is moving further away even if the unemployment rate stays low. And that argues for a more accommodative policy. Luna: But they also have to worry about inflation expectations becoming unanchored. The breakeven rate at 2.23 percent is not alarming, but it's above target. Lucas: Right. So the Fed is walking a very narrow path. On one hand, the jobs data says 'cut rates.' On the other hand, the inflation data says 'hold steady.' And then there's the international context — Christine Lagarde is leaving the door open to an early ECB exit, and that could put pressure on the dollar and complicate the Fed's decisions. Luna: Let's talk about the wage growth component. Average hourly earnings were up 3.9 percent year-over-year in June. That's still above what most economists consider consistent with 2 percent inflation. Lucas: Yeah, that's the rub. If wages are growing at 3.9 percent and productivity is growing at, say, 1.5 percent, then unit labor costs are rising faster than the Fed would like. That puts upward pressure on prices. So even if the headline jobs number is weak, the composition matters. Luna: So what's your read on the Fed's next move? The market is pricing in a cut in September, but is that realistic? Lucas: I think it's realistic but not certain. The Fed has been very data-dependent, and they've said they need to see a 'sustained' pattern of cooling. One month of weak payrolls doesn't constitute a sustained pattern. But if July and August also come in around 100,000 or below, I think the case for a September cut becomes very strong. Luna: And what about the small-cap Russell 2000? It's down half a percent over the past five days, while the S&P is up nearly 2 percent. That divergence suggests the market is pricing in a slowdown that hits smaller companies harder. Lucas: That's a great observation. Small caps are more sensitive to domestic economic conditions and have higher borrowing costs. If the Fed doesn't cut soon, they'll feel the pain more acutely. The Russell's weakness could be a leading indicator that the economy is softening faster than the big-cap indices suggest. Luna: So the Fed is effectively gambling that the labor market can soften without triggering a recession. That's the soft landing thesis. Lucas: It is. And so far, the data is consistent with a soft landing — GDP is still positive, corporate earnings are holding up. But the participation rate falling is a yellow flag. If people stop looking for work, that reduces the economy's potential growth rate over the long term. Luna: Honestly, if walking through the economy with us has made something click, there's a simple way to help keep this show ad-free and independent. Lucas: Yeah, it's buy me a coffee dot com slash fexingo. No pressure, but if today's episode was worth a coffee to you, that link is there. We really appreciate it. Luna: And we get to keep doing episodes like this one, digging into the numbers that matter. Lucas: So back to the Fed's dilemma — I think the key number to watch over the next two months is the participation rate more than the unemployment rate. If participation stabilizes, the Fed can afford to wait. If it keeps falling, they'll have to act. Luna: And the July jobs report will be out on the first Friday of August. That's going to be a big one. Lucas: It really will. And we'll be here to break it down. For now, thanks for listening.