The Fed's full employment puzzle

Even with Friday’s stellar jobs report, it may feel like it's too soon to talk about full employment: America is still 4 million jobs short of where it was pre-pandemic.

• But how close we are has big implications for when the Fed — fresh off a taper announcement — might consider raising interest rates from near zero.

Where it stands: The Fed said last week that full employment is a ways out. Still, a growing chorus of economists says stickier-than-expected inflation may push the central bank to readjust its recovery expectations — and eventually force its hand.

Why it matters: The gloomy outlook for the labor market is suddenly much sunnier, thanks to last month’s hiring surge and hefty upward revisions to job gains in August and September.

• But one thing stayed the same: The labor force participation rate didn’t budge. That measure includes people who don't have jobs but are actively looking.

For reasons that run the gamut — early retirement, lack of child care, fear of contracting the virus, and more — millions have left the workforce. Neither the economic reopening nor rising wages are goosing workers back in significant numbers.

• The intrigue: “The lack of improvement in [labor force] participation coupled with strong wages may eventually force the Fed to rethink its views on how far away they are from the maximum employment objective,” Bank of America economists wrote in a note on Friday.

Between the lines: What full employment will look like — or when the country will get there — is a blind spot for markets.

• Fed chair Jerome Powell says labor force participation is one of many data points the Fed looks at to suss out maximum employment.

• "Ideally ... we would see further development of the labor market in a context where there isn't another COVID spike. We would see: how does participation react in that sort of post-COVID world," Powell told reporters last week.

What we're watching: In recent months, Powell hinted progress for certain ethnic and racial groups, like Black Americans — typically the first to feel the effect of a labor market implosion and the last to reap the benefits of recovery — would also be a factor.

• What they’re saying: The Fed has said they are "focused on fostering a very strong labor market for different demographic groups so that everybody benefits, but strong inflation may limit their ability to be patient on that front," says Steve Friedman, an economist at MacKay Shields who was a former New York Fed official.