You’d have to look pretty hard to find anything not to like in the February employment report. The stock market loved the news that payrolls rocketed, signaling strong economic growth, while wage growth dipped — after an upside scare in January — keeping fears of margin pressure in check.
The unemployment rate remains very low, but it has been at the same level, 4.1 percent, for five straight months. A sub-4-percent rate is just a matter of time, but fears that unemployment would drop rapidly this year, forcing the Fed into more aggressive action to slow the economy, have not been borne out.
At least, not yet. But it’s too soon to declare victory. The household survey, which generates the unemployment rate, is much less reliable than the payroll numbers, and it has recorded 323,000 fewer new jobs over the past five months.
Over time, the numbers move together, and as the gap narrows, the downward pressure on unemployment will re-emerge.
Neither can we be sure that the unexpected rise in labor participation in February will persist. The trend in participation has been flat, net, since early 2014, and each of the four upturns since then has proved to be a false dawn.
February’s spike could easily just be the fifth, though I’m hoping that employers’ increasingly loud complaints about the difficulty of finding qualified staff mean that they might start, finally, to look more deeply into the pool of people currently outside the labor market.
At the same time, people who had given up looking for work might now think it’s worth trying again, given that the media are full of stories about the strength of the labor market. In short, the chance of a sustained rise in participation probably is better now than at any time since before the financial crisis.
A return to pre-crisis levels of participation, or anything like it, is very unlikely. Abundant research shows that structural change in the economy has increased the mismatch between the skills sought by employers and those on offer from people outside the labor force.
In addition, a large number of ex-public sector employees — including teachers and administrators — likely are among the non-participating, because government employment has only just returned to its pre-crash level, while private employment is nearly 10 million jobs higher.
Very small companies, especially start-ups, are responsible for much of the labor demand, but they are not a natural fit for former teachers who have been out of the labor force for some time.
Still, as long as wage growth remains contained, the Federal Reserve can afford to wait and see how the participation story plays out, continuing to raise interest rates slowly and predictably.
Average hourly wages rose only 2.6 percent in the year to February and, with businesses spending more on equipment and software, productivity-adjusted wages— unit labor costs — are no near-term threat to inflation.
The chance of Fed Chairman Powell and his colleagues finding themselves with their backs to the wall this year, fighting an inflation fire, is small.
Looking into next year, though, the labor participation story and its impact on the unemployment rate is paramount. It always seems churlish to argue that falling unemployment sometimes is not a good thing, especially in this cycle, which saw the headline rate peaking at a horrendous 10.0 percent.
But when unemployment is very low, the Fed gets twitchy. Economists argue about how low unemployment can fall without triggering higher inflation, but you’ll struggle to find any serious analyst who thinks the U.S. can run safely with unemployment at 3.5 percent, especially if the trend is still falling when that point is reached.
Unemployment was last that low in 1969, and core inflation was about 6 percent. The world was very different then, and 6-percent inflation isn’t coming back, but the fact remains that the economy has no recent demonstrated ability to sustain such low unemployment without rising inflation.
The Fed will not blithely sit back and run a high-stakes experiment if unemployment heads to 3.5 percent next year; they’ll seek to push interest rates high enough to induce a material slowdown in the economy. Usually, when they try to engineer a soft landing, they cause a recession. For now, though, the sun is shining.
Ian Shepherdson is the chief economist and founder of Pantheon Macroeconomics, a provider of economic research to financial market professionals. Shepherdson is a two-time winner (2003, 2014) of the Wall Street Journal's annual U.S. economic forecasting competition.