After months of an economy that has been prone to contradiction, July’s labor market data seemed to contribute to more of the same mixed signals. However, in our view, the fog is starting to lift, and two metrics in particular are helping clear the air: 1) fewer jobs are now needed to keep the labor market healthy, and 2) economic gains are starting to broaden to include a wider range of households. All told, we see a more positive backdrop forming heading into the second half of the year.

Labor Market

In July, the U.S. economy lost 23,000 jobs, even as the unemployment rate ticked down to 4.1%.¹ While the signals seem mixed, the deeper you dig, the more the data points to an economy adjusting to a shrinking workforce.

By historical standards, the unemployment rate is remarkably low – the kind of number that would typically signal a labor market firing on all cylinders. But the reality has felt different all year. The labor market has been stuck in a “low-hire, low-fire” holding pattern, punctuated by steady headlines about layoffs, and that undercurrent has been hard to ignore. July’s jobs report reignited those concerns as payrolls came in well below expectations, and downward revisions to prior months only reinforced that something is off. And yet, somehow, the unemployment rate has fallen even further. So, what is actually happening?

The answer isn’t that the unemployment rate fell because jobseekers found jobs. It fell because people stopped looking for them. The Labor Department’s household survey showed the number of employed Americans fell by 87,000 in July, but the labor force itself shrank by a much larger 264,000. When people exit the labor force entirely, whether by choice or discouragement, they are no longer counted as unemployed. The math mechanically pulls the rate down, even as fewer people are actually working.

On its face, this sounds scary, as if the economy is so weak that people are simply choosing to drop out of the workforce entirely. But like everything in this current environment, it pays to look deeper. One element at play is the aging of the workforce. The youngest baby boomers turn 62 this year, old enough to start claiming Social Security, just as the supply of younger workers ready to take their place continues to shrink. At the same time, the current administration’s immigration policies have curbed the flow of foreign-born workers, one of the few reliable sources of labor-force growth in years past.

Taken together, there is a real argument that this isn’t so much a weakness as it is a resizing. Economists at the American Enterprise Institute and Brookings have estimated that the economy now needs to add only around 15,000 jobs a month to hold the unemployment rate steady, a fraction of what would have counted as healthy job growth just a few years ago.² Under that framework, the past seven months look less alarming; even with July’s outright loss factored in, the economy has still added an average of roughly 61,000 jobs a month.³ This may not be evidence of a stalling economy; instead it could mean that the economy is simply adjusting to a shrinking supply of available workers (Figure 1).