Jobs report shows supply returning even as Fed focuses on demand

The August U.S. jobs report contained hints of a long-awaited increase in labor supply. The big question for the central bank is whether that can continue even as it attempts to engineer an economic slowdown.

The labor force participation rate jumped to 62.4% last month, pushing the unemployment rate up to 3.7% as the share of those entering the job market who managed to find work declined. But the influx of Americans looking for work still came in the context of continued strong job creation, which historically has been a necessary ingredient for enticing people into the job hunt.

That presents a new wrinkle for the Federal Reserve as it confronts the highest inflation in almost four decades. It has largely given up this year on waiting for increases in the supply of goods, services and labor — all of which have been curbed by the pandemic — to put downward pressure on consumer prices and worker pay. Instead, it has turned its focus to bringing down demand via rapid interest-rate increases.

If participation continues to rise, it could bolster the case at the Fed for a less-aggressive tightening path and raise the chances of a “soft landing” for the U.S. economy. But with only one month of data in hand, that’s still a big “if.”

“What we learned in the report today is that it’s not crazy to think we can be in an environment where we still see this expansion on the labor supply side, and that allows us to ‘land the plane,’ so to speak,” said Julian Richers, an economist at Morgan Stanley in New York. “This definitely contributes to the optimism that they can manage a soft landing.”

After the publication of the monthly Labor Department report on Friday, investors dialed back expectations for the size of the rate hike Fed officials will opt for at their Sept. 20-21 policy meeting, erasing all of the extra tightening they priced in following Chair Jerome Powell’s hawkish Aug. 26 speech in Jackson Hole, Wyoming.

Powell had said “there is clearly a job to do in moderating demand to better align with supply,” adding that the process “would bring some pain to households and businesses,” which investors interpreted as auguring for another three-quarter percentage point increase in the central bank’s benchmark rate, following hikes of the same size at each of its last two meetings.

Now, it’s looking more like a toss-up between that and a half-point increase, according to federal funds futures contracts. Another Labor Department report on consumer prices for the month of August, due out Sept. 13, will probably be decisive.

The question for the remainder of the year is whether or not the increase in participation in August was a one-off effect related to a receding pandemic, and whether it can be sustained even in the face of slowing job growth, which many forecasters expect to see as higher interest rates start to weigh on the economy.

“Can you erode demand and boost supply at the same time? Maybe at the margin you can, if people are ready to go back to work, and it’s more of a behavioral change or a psychological change — that it’s a new school year, and it’s time to end this pandemic sabbatical and get back in the labor market,” said Nela Richardson, the chief economist at Automatic Data Processing in Roseland, New Jersey.

“The problem here is if companies start to pause, or be more conservative, in their hiring as a bunch more people come in,” Richardson said. “There’s been a timing mismatch this whole time: First, firms were ready and workers weren’t. Now, workers may be ready and firms may be pausing.”

Labor force participation for Americans between the ages of 25 and 54 jumped to 82.8% last month from 82.4% in July, bringing it just shy of the Feb. 2020 level of 83%. Participation for younger Americans — those between the ages of 16 and 24 — rose too, but at 55.7% is still some way from the pre-pandemic rate of 57%. For Americans of the ages 55 and older, participation actually fell, to 38.6% — well below the February 2020 level of 40.3%.

More labor supply may also have helped put downward pressure on wages: Average hourly earnings rose just 0.3% in August, marking the slowest pace of increase since February. A separate Labor Department report published earlier in the week showed the percentage of Americans who quit their private-sector jobs in July sank to the lowest level in over a year, which may be helping curb wage pressures too.

Some of the details in the participation data, though, were less optimistic. Friday’s report showed participation for White Americans rose by two-tenths of a percentage point in August, while that for Black Americans fell by the same amount. It marked the third straight month of declines in the Black participation rate.

For William Spriggs, the Howard University economics professor and AFL-CIO chief economist, that’s a harbinger of things to come.

“Black people are the canary in the coal mine,” Spriggs said. “When you see Black labor force participation drop like that, that means that Blacks are finding it too hard, and more of them are just saying, forget it.”