Will a falling unemployment rate keep U.S. inflation above target?

The U.S. labor market has been contracting over the past year, with unauthorised immigrants departing and the labour force participation rate declining. BCA Research explores whether this contraction in the labor force will allow the unemployment rate to fall, thereby keeping inflation above the Federal Reserve's target. Jonathan LaBerge, a strategist at BCA Research, notes that the relationship between unemployment and inflation, as described by the Phillips Curve, is conflicting.

From 1999 to 2000 and 2018 to 2019, low unemployment rates occurred without high inflation, but the late 1960s and 2022 to 2024 saw high inflation alongside low unemployment. Typically, a below 4% unemployment rate leads to inflationary pressure, but no productivity gains like those in the 1990s are evident today. Additionally, inflation expectations have been lower in recent years, which may restrain wage growth.

LaBerge argues that fears of a significant wage growth breakout are overblown, as the power dynamics between workers and employers have shifted too far. Post-pandemic wage growth was driven by a labour supply shortage, with record quit rates indicating poaching between firms and generous fiscal transfers slowing labour re-entry into the workforce.

Employers now face fewer incentives to raise wages due to the negligible cost of posting job openings online. BCA Research believes that structural forces favour employers, while workers have less leverage against management focused on shareholders, given the collapse in private-sector union membership. While a wage-price spiral is not currently occurring, there is a possibility that the Federal Reserve could deliver a hawkish surprise within the next 12 months, according to BCA Research.