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A hallmark of the Great Recession was a decline in the prime age labor force participation rate from 83% to 80%, see the chart below. While a three-point drop might not seem significant, it reflects millions of Americans walking away from the economy, giving up on ever finding gainful employment. The economic and societal consequences of that dynamic were staggering.
Fortunately, over the past few years our long-lived economic expansion managed to produce both a level of demand for labor and gains in wages – north of 3% – significant enough to pull millions of Americans back into the workforce. Said differently, millions of Americans have been welcomed back to the economy, which is reflected in a rebound in the labor force participation rate to north of 82%. And while that is great and welcomed news for those Americans and their families, a tightening labor market and rising wages also pose risks to the markets and economy. To better appreciate this seemingly counterintuitive point, we have to remember that significant slack in the labor market post the Great Recession helped keep a lid on both interest rates and inflation, which was bullish for risk assets and supportive of economic growth. The risk now is that as the job market continues to tighten and wages continue to rise, the Federal Reserve will be forced to raise interest rates further, and in doing so will make the cost of capital too expensive, choking off corporate and consumer spending, ultimately putting the economy into a recession and stocks into a bear market.
While we do think inflationary and interest rate risk is underappreciated by many market participants, we also continue to see enough capacity in the labor market that wage inflation and broader inflation shouldn’t become a real risk to the economy and markets until sometime in 2020, at the earliest.