Labor supply is in a structural downtrend
The labor force participation rate, at 62.4%, has drifted higher in January but remains well below pre-pandemic levels. The decline is being driven by older workers (aged 55+ years) leaving the labor market due to illness from long Covid, or early/normal retirement. This suggests a structural limit to the number of employable workers, or the labor supply and continues to complicate the Fed's job even more as policy makers try to crimp demand to push wage inflation lower.
The January NFP saw a significant upward revision for the last several months, somewhat resolving the puzzle of “missing” workers. But also consider that China’s population dropped by 850,000 people last year to 1.4118 billion, and this will mean a structural drag on global labor supply in the years to come.
As we have highlighted previously, markets are closely watching the developments in the US labor markets, with wage growth remaining a key driver of inflation and the path of Fed policy from here. From what it appears currently, the labor market remains far too tight and still a long way off levels that are consistent with bringing inflation back to 2% levels. Even as the labor market is loosening from peak tightness, it is rather gradual and much slower than the Fed forecast. Slowing wage growth may be an argument to support the Fed’s ‘disinflation’ rhetoric, but it is still hard to make a decisive turn.
Watching labor market data will be key from here, and that will include anything from the weekly jobless claims to JOLTS reports, Atlanta Fed wage tracker, to the employment cost index (ECI) and nonfarm payrolls. Next ECI is due on April 28, and that will be a key signal for the Fed to understand how wage dynamics are developing. But for now, there is enough reason for the Fed to continue to push for higher rates and drive out market’s expectations of this year’s rate cuts.