Jerome Powell this week threw the market in by hinting that the Fed will be patient in raising short-term interest rates due to ongoing stagnation in the US labor market and potentially “temporary” inflation. However, today the unemployment rate fell more than expected to 4.6%, which is a relatively low level of unemployment. Wouldn’t an unemployment rate as low as 4.6% cause the Fed to at least start talking about reducing asset purchases faster or even raising interest rates?
As always, the devil is in the details. When looking at why the unemployment rate fell in October, one of the main reasons was that the work participation rate was also low! This means that the unemployment rate is down, in part, because so many people are out of the job market. The smaller job market is troublesome because it means:
- skills mismatch between employers and job seekers, which is bad because it could mean that the participation rate will be slow to recover and
- It also means a lower level of growth, as GDP growth = labor force growth * productivity growth
As the reader can see, the engagement rate has dropped from around 63.5% before COVID to just 61.6% today. The overall engagement rate has been flat for a year and a half now.
When we delve into the participation rate, we notice that all ages of workers drop out of the labor market. In the 55+ category, the participation rate is 2% below the pre-COVID level and shows no signs of improvement. In the 25-54 class, the participation rate is also 2% lower than it was before COVID, but at least it is on an upward trajectory.
In aggregate, low labor force participation has reduced the total workforce in the United States from 159 million pre-COVID to 154 million today, or a total loss of 5 million jobs.
The loss of 5 million jobs ignores that, but for COVID, the total number of employees in the US was likely to grow due to population growth and millennials entering the workforce faster than boomers exit. If the US labor market continues to add jobs through 2021, total US employment will be over 162 million so far. So, the total number of individuals who are not in the labor market, but could be, may actually be over 8 million (162 million to 154 million) over 5 million.
What would cause the Federal Reserve to raise rates even though as many as eight million people may be out of the labor market and the participation rate is making no progress? Inflation of course.
But, we must also take note of how the Fed views the world. The Fed sees a link between employment and inflation. In fact, while this link oscillates and flows through time, it was powerful in the post-great financial crisis era. As the reader can see, the employment participation rate and the CPI have moved in the same direction since 2009…until 2021. The fact that the participation rate has not made any progress in nearly 18 months is a strong data point that would suggest the Council Federal Reserve that inflation is “temporary”. If inflation is ‘temporary’ then there is no need to tighten policy aggressively.
Maybe that’s why the two-year yields have fallen by 10 basis points in the past several days, gold is up a little, and the Fed Funds futures market has started cutting rates for 2022 rate hikes?