Economists at around half of the 25 dealer banks that trade with the Fed currently expect the US to avoid a recession over the next year or two.
Many see unemployment rising nonetheless, and the assumption that a substantial amount of that increase will be accounted for by rising participation is critical to the no-recession call.
Barclays economists, for example, see the unemployment rate rising to 4.2% by the end of next year as more Americans start looking for work again in the face of a slowing economy.
That view is shared by economists at Bank of Montreal, who see unemployment rising as high as 4.6% in 2023, even as the economy skirts an outright recession. Labor force participation, they say, will rise to 62.9% -- accounting for roughly half of the increase in the jobless rate.
“There’s still that legacy of people who are not in the labor force now that were either working before or looking for work before, and aren’t now because of the pandemic,” said Michael Gregory, deputy chief economist at Bank of Montreal in Toronto.
Fed officials have been waiting for participation to normalize and have often cited its failure to do so as a contributing factor behind the highest inflation in almost 40 years.
“We have been disappointed that labor force participation really hasn’t moved up since January. That may be related to yet another big wave of Covid,” Chair Jerome Powell said on July 27. “So, we’re not seeing much in the way of labor supply.”
That’s part of the reason why the Fed has raised rates quickly this year to curb demand. Officials see unemployment rising by about half a percentage point in the coming years without triggering a full-blown recession, according to their projections in June.
In that scenario, the Fed brings labor demand down somewhat in the near term, while the supply steadily normalizes over time.
But there’s a risk in viewing the two as independent of each other.