Unemployment rose, for a good reason

The unemployment rate rose from 3.5 to 3.8 per cent in August, and the first commentaries warned of a turning cycle. The detail says otherwise. Unemployment rose because 736,000 people came back into the labour force, lifting the participation rate to a post-pandemic high of 62.8 per cent.

Reading the household survey

The jobless rate comes from a monthly survey of about 60,000 households, separate from the employer survey that produces the payroll count. In August it found that most of the newcomers had not yet landed a job, so the number of unemployed rose even though the number in work also increased. That is the signature of people returning to look for work. A recession looks different: employment falls, the unemployed are mostly people who have lost their last position, and the labour force tends to shrink as discouraged workers give up.

The employer survey tells a similar story. Payrolls rose by 187,000 in August, a moderate pace but far from the contraction that marks a downturn. Average hourly earnings rose 0.2 per cent in the month, an increase that sits comfortably with inflation heading back toward the Fed's 2 per cent target. Neither figure resembles the start of a slump.

The two surveys disagree often enough that neither should be read alone. The household survey counts people, including the self-employed and farm workers, while the payroll survey counts jobs, so a worker with two part-time posts appears twice in one and once in the other. Over several months, however, they tend to converge, and both now describe a labour market that is slowing without contracting. That agreement is what gives the benign reading its weight.

More workers, cooler wages

For the Federal Reserve, a growing labour force is about the best news it could get. It eases staff shortages and cools wage growth, and it adds to the economy's capacity without anyone being laid off. When the jobless rate rises because people who had stopped looking are seeking work again, that points to a lively economy. Companies are not in trouble.

The mechanism runs through bargaining power. When each vacancy draws more applicants, employers need not outbid rivals to fill it, and staff find it harder to win large rises by threatening to leave. Pay settlements then drift toward the pace of productivity growth plus the inflation target, which is where the Fed wants them. The adjustment comes through more competition for jobs, with no need for mass redundancies.

The sectors that struggled hardest to hire stand to gain most. Health care, leisure and hospitality have supplied a large share of this year's job gains as they refill posts left empty since 2020, and a deeper pool of applicants lets them do so without bidding up pay across the economy. For bond investors, a labour market that loosens through supply rather than layoffs strengthens the case that the Fed has finished raising rates, now between 5.25 and 5.50 per cent, without bringing forward the first cut.

Where the new workers come from

Two sources explain the rebound. Participation among Americans aged 25 to 54 has recovered above its pre-pandemic level, helped by the return of women to work and by jobs that can be done partly from home. Immigration, which slowed sharply during the pandemic, has picked up again and added to the working-age population. Ageing pulls the other way as the baby-boom generation retires, which is why overall participation remains below where it stood in early 2020.

The late 2010s offer a guide. As that expansion matured, people who had drifted out of the labour force after the financial crisis came back, and unemployment fell to 3.5 per cent in 2019 while core inflation stayed below the Fed's target. A steady flow of returning workers let the economy grow without the wage spiral that the old Phillips curve predicted. The same mechanism appears to be at work now, though from a starting point of much higher inflation.

The supply response also explains a puzzle of the past year. Job openings have fallen by millions from their peak without a matching rise in unemployment, which many economists said could not happen. If employers were cancelling vacancies because more candidates were applying for the ones that remained, fewer adverts and steady employment are exactly what one would expect. Rising participation and falling vacancies are two sides of the same rebalancing.

The less cheerful reading

The strongest counterargument is that people are returning to work because they have to. Prices have risen faster than wages for much of the past two years, pandemic savings have been run down, and student-loan repayments resume in October after a pause of more than three years. Workers pushed back into the labour market by financial strain are a sign of stretched household budgets, and stretched budgets eventually mean weaker spending.

That argument has some force, but it does not yet match the data. Consumer spending has held up through the summer, and the rebound in participation has been concentrated among prime-age workers rather than among older people who retired early and might be returning out of necessity. Even if strain is part of the story, the effect on inflation is the same: more people competing for jobs slows pay growth. The question for the Fed is whether spending weakens before inflation falls far enough, and August's figures do not answer it.

What could spoil the story

One month of household data is noisy, and monthly changes in the jobless rate carry wide margins of sampling error. Some of August's weakness was also specific: the collapse of the trucking firm Yellow and the strikes in Hollywood both cut payrolls. If unemployment keeps climbing through the autumn while participation stalls, the benign reading would fail. The Fed's updated projections at this month's meeting and the September jobs report, due in early October, are the next checks.

Consumer prices for August, published next week, and the Fed's own verdict on 20 September will show how much weight officials put on the supply story. This rise in unemployment is good news. More workers should cool wage-driven inflation over the coming months, and the Fed will not have to crush demand to get there; the likeliest result is that rates stay on hold this month while pay growth keeps easing through the end of the year.