The Big Idea

Assessing the labor market moderation

Stephen Stanley | September 13, 2024

This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors. This material does not constitute research.

Most of the concerns related to the weakening economy in recent months are centered around rising unemployment. The jobless rate fell as low as 3.4% in early 2023 and has steadily risen since then, including a string of four consecutive monthly increases from April through July. Examining some of the underlying details from the household survey offers some insight on the dynamics of the labor market. Those details argue that the labor market has not deteriorated by as much as the unemployment rate would suggest.

A labor supply bulge

There has been a massive amount of discussion and debate about the growth of the working-age population in recent years. The acceleration of immigration has generated controversy politically, but its economic implications have also been noteworthy. The timing was fortuitous. From an economic standpoint, the perfect time to have a sharp influx into the labor force would be when the demand for workers is red-hot and the labor market is in the midst of a shortage of workers. Check. The labor situation in 2021 and 2022 certainly fit that description.

Now that the demand for labor has moderated, the need for such a large inflow of new workers is less acute, and, not surprisingly, the politics on this topic have begun to shift. As a result, the Biden Administration has already taken steps to dramatically slow the pace of immigration, and it is reasonable to expect that, regardless of the outcome in November’s election, the growth in the working-age population will return to closer to pre-pandemic trends going forward.

While immigration has garnered most of the headlines, however, the Labor Department data suggest that it has been the participation rate more than swings in the population that appear to be driving joblessness up.

In any case, Fed officials have highlighted the unusual nature of the rise in unemployment over the past year. Chair Powell noted in his Jackson Hole speech: “So far, rising unemployment has not been the result of elevated layoffs, as is typically the case in an economic downturn. Rather, the increase mainly reflects a substantial increase in the supply of workers and a slowdown from the previously frantic pace of hiring.”

On September 6, Governor Waller was even more explicit: “most of the increase in the unemployment rate is from workers entering the labor force and not finding jobs right away. So, the recent rise in the unemployment rate appears to be more of a supply-side-driven phenomenon, not demand driven.”

This is an unusual state of affairs. Traditionally, the labor market rises and falls mainly due to swings in the demand for workers. Labor supply is somewhat flexible, as marginal potential workers can be drawn in, for example by higher pay, but the cyclical swings in the unemployment rate tend to be governed primarily by the demand side.

The last several years have been unique in that respect. First, the pandemic-era labor shortages in 2021 and 2022 severely curtailed the ability of firms to fill all of their desired positions. And then the rapid influx of working-age people helped to alleviate those shortages more rapidly than expected.

Many financial market participants have treated the backup of the unemployment rate over the past year or so as the same as in past episodes, but Fed officials are clearly viewing the current situation as unique, as laid out by Powell and Waller. Other Fed officials have made similar comments.

Labor force participation

The household survey divides respondents into three groups: employed, unemployed (not working but actively looking), and out of the labor force (not working and not actively seeking a job). The two key ratios that summarize the survey results are the labor force participation rate (LFPR), defined as the first two groups divided by the full working-age population, and the employment-to-population ratio (EPR), which is the first group divided by the total working-age population.

The evolution of these two ratios bolsters the case put forward by Powell and Waller. The EPR has been largely steady over the past two years. In December 2022, when the unemployment rate was 3.45%, just two basis points above the eventual low for the cycle (and for the last 50 or more years), the EPR was 60.15%. In August, it was little changed at 60.04%. To be fair, the EPR did rise somewhat further in 2023, climbing to a peak of 60.4%, but it has moved remarkably little over the past two years, especially in light of the substantial backup in the unemployment rate this year. If this were a garden-variety demand-driven backup in the unemployment rate, then the EPR should have declined much more.

In contrast, the evolution of the LFPR has been puzzling. Keep in mind that the aging of the domestic population has been driving the aggregate LFPR lower for nearly 20 years. This is because the working-age population, the denominator in these calculations, is defined as ages 16 and over, so as a rising percentage of that demographic reaches retirement age, the LFPR will naturally drift downward. The LFPR peaked in the late 1990s at around 67% and declined to below 63% over the next 20 years. The underlying trend based on demographics suggests that the LFPR should fall by around a quarter of a percentage point a year.

Participation sank during the pandemic and then rebounded in 2021, 2022, and early 2023. By June 2023, the LFPR had recovered to 62.6%, seven tenths of a percentage point below the December 2019 level, not far from what the pre-pandemic trend would have dictated. Over the following 14 months, the LFPR, rather than sliding by another three tenths or so, as the prior demographic trend would suggest, has actually risen by a tenth on balance to 62.7%.

The LFPR is running about four tenths higher than the underlying demographic trend would project. Some of this divergence could reflect the upheaval within the labor force driven by the recent immigration bulge or it may stem from other drivers. In any case, if the LFPR had adhered to the long-run trend since mid-2023, then the labor force would have been over 1 million smaller. In that hypothetical, assuming no change to the level of employment, the unemployment rate would be 3.6% or 3.7% rather than the current 4.2%, and we probably would not even be discussing the prospect of labor market weakness.

Breaking down the labor force by age

The household survey data are broken down into a number of age brackets. The performance of labor force participation across different age groups is quite interesting.

“Prime-age” labor force participation (ages 25-54) has surged over the past couple of years. The prime age LFPR rose this year to 84% for the first time since 2001 (Exhibit 1). In fact, recent readings have been quite close to the all-time highs seen in the late 1990s. This cohort is responsible for the outperformance of the aggregate LFPR relative to the long-established demographic trend laid out above. It is not entirely clear if this is related to the immigration surge or to a greater willingness to work than before—perhaps due to the tight labor market generating upward wage pressure—or both.

Exhibit 1: Prime-age (ages 25-54) labor force participation rate

Source: BLS.

For those aged 55 and over, labor force participation fell during the pandemic for understandable reasons, rebounded over the following few years, and has roughly levelled off over the past year (Exhibit 2). The August 2024 reading of 38.7% was little changed from the 38.6% August 2023 level.

Exhibit 2: Labor force participation rate ages 55 and over

Source: BLS.

Finally, there has been a tremendous amount of noise for the younger cohort, ages 16 to 24 (Exhibit 3). There appears to be a recurring pattern of labor force participation dropping in the summer and then reviving when school resumes in the fall, with the magnitude of the swing rising in each of the past few years.

Exhibit 3: Labor force participation rate ages 16 to 24

Source: BLS.

However, the volatility in the 16-to-24 age group is not limited to labor force participation. This cohort has also seen a massive drop in employment and a substantial rise in unemployment since April (I wrote about the outsized swings in these data in May in a previous piece, and the figures have yet to reverse). So, for young people, employment levels have declined even more sharply than the labor force. As a result, the unemployment rate for this cohort has surged over the past four months from 8.2% to 9.7%. In fact, even though this group makes up only about 15% of the working-age population, it accounts for roughly half of the rise in the jobless rate since April. The overall unemployment rate has moved from 3.86% in April to 4.22% in August, but the jobless rate for those ages 25 and over has only inched up from 3.2% to 3.4%.

The swings in the younger cohort are a mystery. It could be random statistical noise, or it could be a real phenomenon. My best guess is that the summer job market for college graduates and college students looking for summer internships was especially tough in 2024. If that hypothesis accounts for at least a part of the explanation, then we may see a reversal in September, when college students would have returned to class. It will be interesting to see whether this dynamic plays out, and, if it does, if it has a noticeable impact on the overall unemployment rate.

Conclusion

The movements in the household survey data pose a number of difficult questions and do not neatly conform to a simple narrative, such as a straightforward result of an immigration bulge. In the aggregate, household employment has been surprisingly weak, while the labor force participation rate has outperformed the longstanding trend. Both of these divergences have contributed to a rising unemployment rate, raising doubts as to how we should interpret the backup in the jobless rate. The extreme moves in recent months in employment and unemployment for those 24 and younger add further doubt to how the household survey results should be interpreted. I am keen to see whether these anomalies reverse in September, once college classes resume. Regardless, I am skeptical that the labor market has deteriorated by as much as the unemployment rate, taken at face value, would suggest.

Stephen Stanley
stephen.stanley@santander.us
1 (203) 428-2556

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