The unemployment rate dropped last month to 7.3 percent, which is the lowest level since December 2008. The decline was attributed to the contraction in the workforce and not because more people got jobs. Labor force participation, which is the share of working age people who has a job or searching for one, is on a 35 year low.
Analysts said that the drop in the workforce could be a problem for the Federal Reserve, as it considers starting to pull back its stimulus program. The unemployment rate has been falling faster than the prediction of the Fed but the reason for the decline was not the right one.
The unemployment rate is vital because Fed Chairman Ben S. Bernanke and his colleagues have established it as the basis for policymaking. Bernanke said he expects the Fed to stop its bond buying program in the middle of 2014 when the jobless rate is around 7 percent.
As long as inflation is controlled, the Fed said it wouldn’t consider increasing its interest rate until unemployment rate drops to 6.5 percent. The Fed cut the overnight interbank rate to zero in December 2008 and has held it at that level since.
Policy makers have to decide how much of the decline in the participation rate is long lasting and how much is temporary. If the drop is due to demographics then the lower jobless rate indicates a true picture of the amount of slack left in the labor market. If the contraction is due to discouraged job hunters giving up then the jobless rate doesn’t show the true state of the market.
Both scenarios have implications for bond investors. A faster swing from stimulus to austerity by the Fed could result to higher yields on Treasury securities. Analysts expect the yield on 10 year Treasury note to go up to 3.25 percent by the end of the year as jobs market remains strong.
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