Chief Global Strategist
In a generally upbeat Jackson Hole speech on Friday, Fed Chairman Kevin Warsh asserted that “labor markets are consistent with full employment”. Given that the current unemployment rate, at 4.1%, is the lowest it’s been in 18 months and is also lower than it has been 88% of the time over the past 50 years, it is hard to argue with the Chairman’s assessment.
However, it is a very strange labor market and it is important for investors to unravel its apparent contradictions in order to assess what it really means for economic growth, inflation, monetary policy and, ultimately, investment performance and risks. In particular, today’s labor market data raise at least three important questions:
- Why is job growth so weak in a moderately-growing economy?
- Why is the unemployment rate so low, given such weak job growth? And,
- Why, if the labor market is so tight, isn’t wage growth stronger?
Why is Job Growth so Weak in a Moderately-Growing Economy?
In the 20 years before the pandemic, real GDP grew at an annual pace of 2.11% and payroll employment grew by 0.75% per year. However, over the two years that ended in the second quarter of 2026, while real GDP grew at an almost identical pace of 2.09%, payroll jobs climbed just 0.39% per year, or likely 0.37% after the implementation of a small benchmark revision announced last Friday . So why hasn’t average economic growth produced more jobs?
The most likely answer is composed of four parts.
- First, over the first 20 years of this century, the 0.75% annual increase in the number of jobs was accompanied by a 0.12% annualized decline in the average workweek for private sector production and nonsupervisory workers. Assuming a similar trend for all workers, total hours worked would have only climbed by 0.63% per year. By contrast, over the past two years, the average workweek for private sector production and nonsupervisory workers rose by 0.10%, so, assuming a similar trend for all workers, total hours worked would have climbed by 0.47%. So instead of having to explain a 0.38% gap, we only have to explain a 0.16% gap.
- Second, the slowdown in job gains has occurred at a time of severely restricted labor supply. This very likely does force productivity gains as employers are forced to make the most of the labor they have.
- Third, it is possible that there has been some productivity gains directly from AI and,
- Fourth, much of the economic growth of the past two years has come from investment spending equipment and intellectual property, neither of which are particularly labor intensive. Indeed spending in these areas has increased at a 7.9% annual rate over the past two years, more than six times faster than the rest of the economy.
Given all of this, it’s not surprising that jobs have grown so much more slowly than GDP.
Why is the Unemployment Rate so Low given Such Weak Job Growth?
GDP data are recorded on a quarterly basis. However, jobs are reported monthly allowing for a slightly more precise statement of the second mystery. In the first 20 years of this century average monthly payroll job growth was 88,000. Over the past 24 months, it has been just 46,000. Yet the unemployment rate last month fell to 4.09%, an 18-month low and down from 4.21% in July 2024. How can 46,000 new jobs per month be enough to reduce the unemployment rate?
The reason, at least according to government data, is a falling labor force participation rate.1 Over the past two years, while the civilian population aged 16 and older has risen by a reported 277,000 per month, the labor force, that is those among that group who are either working or actively looking for a job, has risen by just 29,000 per month.
While these raw population numbers should be treated with a great deal of skepticism, the labor force participation rate, which is based on the monthly current population survey should be less problematic. Between July 2024 and July 2026, it fell from 63.18% to 61.84% or by 1.34 percentage points. While this may not sound like a huge change, it amounts to 3.7 million missing workers. That is to say, if the labor force participation rate hadn’t fallen over the part two years, the U.S. labor force would have grown by 157,000 more people per month and would now be 3.7 million larger.
So why has labor force participation fallen so dramatically?
The big reason is the aging of the population. The labor force is defined as the civilian, non-institutional population aged 16 and older that is either working or actively looking for a job. Labor force participation falls sharply at the traditional retirement age of 65 and then continues to fall as people age further. As the baby boom generation is aging, more are crossing the threshold into retirement. Indeed, if the age structure of the civilian population, using five broad age groups, had been the same in July 2026 as in July 2024, that alone would have reduced the decline in the labor force participation rate from 1.34 percentage points to 0.59 percentage points.
Beyond this, labor force participation within age groups provides further hints. While the labor force participation rate of those aged 18 to 64 only fell by 0.34 percentage points over the past two years, the participation rate for those over the age of 65 fell by 1.13%. This could, in part, reflect stock market gains that have allowed some who weren’t financially able to retire to do so. However, it could also just reflect the further aging of the baby-boom generation as those who weren’t ready to retire at 65 finally do so at 70.
Finally, the decline in the labor force participation rate may be somewhat connected with a now relatively long period of low unemployment. In general, those unemployed can receive unemployment benefits for up to 26 weeks provided they are actively looking for a job and often longer in the immediate aftermath of a recession. This provides an incentive for them to say that they are actively looking for a job when participating in a government survey. However, once those benefits have expired, there is less incentive to do so, and so they may officially drop out of the labor force altogether.
Why, if the Labor Market is so Tight, is Wage Growth so Subdued?
In July, the average hourly earnings of all private sector workers were up just 3.15% year-over-year, the smallest gain since May 2021 and lower than the year-over-year CPI inflation rate for a fourth consecutive month. Given record corporate profits, a growing economy and a very tight labor market, why can’t workers get stronger wage gains?
Part of the answer may be that workers just don’t recognize that it is a tight labor market. In July, while the unemployment rate was lower than it has been 88% of the time over the past 50 years, the Conference Board survey revealed that the gap between those saying jobs were “plentiful” rather than “hard to get” was only higher than it has been 62% of the time over the same period. Moreover, while unemployment is relatively low, so is hiring, so workers may be finding it unusually hard to move to another job that will pay them more.
Another part of the answer is that workers don’t have the same union representation as in the past. Fewer than 7% of private sector workers were represented by a union in 2025 with the rest of the workforce forced to bargain for themselves.
Investment Implications
It should be said these labor market mysteries were particularly notable in the July 2026 jobs report. If the vagaries of data collection and seasonal adjustment made some of these July readings extreme, the August report, due out on Friday, could well show better payroll job growth, a higher unemployment rate and stronger wage gains. However, the broad trends will likely remain.
This suggests, first, that the economy doesn’t have quite as much momentum as Kevin Warsh suggested in his Jackson Hole speech. Anemic job and wage growth will continue to suppress the demand for houses, light vehicles and a host of other consumer goods and services, particularly after the stimulus effects of income tax refunds and tariff refunds have faded. Very slow job growth probably makes the economy somewhat more vulnerable to recession also.
In addition, the weakness in wage gains is very important for the inflation outlook. If higher prices for goods and services don’t flow through to higher compensation, it is impossible for the economy to generate a price-wage spiral. Moreover, weak demographic and job growth could lead to a continued rise in rental vacancy rates, holding down rent growth and, thereby, measures of owners’ equivalent rent. This should keep CPI on a downward track.
All of this suggests that the economy is somewhat slower-growing and less inflation prone than portrayed by Chairman Warsh on Friday. Given this, markets may have been premature in now assigning a 60% probability to a September rate hike, up from 40% at the start of last week. While investors should be prepared for possible policy mistakes, there is little in the labor market to suggest inflationary trouble ahead.