Recent economic data show that the US job market is showing signs of cracks. Friday’s jobs report is expected to provide crucial insights into whether the labor market can maintain steady but slower growth. Federal Reserve Chair Jerome Powell recently noted that the labor market has returned to pre-pandemic levels, but downside risks are now real.
The labor market is more vulnerable to a rapid weakening if there is an unexpected shock or interest rates remain too high. Key indicators to watch include the unemployment rate, which has seen first-time applications for jobless benefits rise to an estimated 249,000 filings, the highest since last August. Continuing claims have increased to 1.877 million, the highest since November 2021.
The prime working-age employment-to-population ratio held at 80.8% in June, near the 23-year high of 80.9%. Overall, labor force participation has improved since the pandemic crash, ticking up to 62.6%, but an aging workforce constrains its growth. Economists also look at the temporary help services industry, often seen as a “canary in the coal mine” for future employment shifts.
The sector has seen a job decline over the past two years, but this has not translated into a drastic fall-off in the overall labor market. Pay growth continues to cool, alleviating fears of a wage-price spiral. The new Employment Cost Index data showed wages and benefits rose more slowly than expected in the second quarter.
Compensation costs slowed to 4.1% on an annual basis. The US job market has historically experienced periods of expansion, with the current growth being one of the longest on record. However, a few industries have driven much of this growth, primarily health care, government, and leisure and hospitality.
Friday’s report will be crucial in understanding whether the labor market is resilient enough to maintain steady growth despite the prevailing economic uncertainties. In his latest press conference, Federal Reserve Chair Jerome Powell described the US labor market as “strong, but not overheated.” The second half of that statement is undoubtedly true. According to almost every conceivable measure of labor tightness, the US labor market has cooled off.
But it’s unclear how long the US labor market can stay strong.
Fed’s focus on job market trends
By holding off on cutting interest rates today, the Federal Open Market Committee is betting the labor market is strong enough to wait until the fall for confirmation that inflation is returning to 2%.
The Federal Reserve is grappling with issues beyond inflation, as new economic data suggests a shift in focus may be necessary. While the Fed has been reluctant to commit to an autumn interest-rate cut, recent job market data could expedite a September rate reduction. Fed Chairman Jerome Powell hinted at this change on July 31, stating that the risks to the central bank’s mandate were moving into “better balance.” Powell referenced the weakening labor market, which the Fed is tasked with supporting alongside keeping prices stable.
New data from the Labor Department shows that conditions remain challenging. As of July 27, around 250,000 Americans filed for unemployment benefits, the highest level in nearly a year. Continued claims hit 1.88 million, the highest since 2021.
A deeper look into July’s manufacturing PMI survey from the Institute of Supply Management shows that the share of managers expecting hiring to slow is at its highest level in nearly two years. ISM Chairman Tim Fiore noted, “Respondents’ companies are continuing to reduce headcounts through attrition and hiring freezes.”
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However, in July’s nonfarm payrolls report, Wall Street still anticipates a relatively solid gain of 148,000 new jobs. Despite this, wage increases are expected to be muted, with employers tightening their belts as they head into the second half of the year.
Earlier this week, payroll-processing group ADP reported a smaller-than-expected total of 122,000 new private-sector hires last month. The pace of wage gains has eased to the slowest in three years. A separate report showed that unit labor costs saw their smallest increase in three years.
Powell reiterated that a rate cut “could be on the table as soon as the next meeting in September” if the labor market remains steady and inflation pressures continue to ease. However, some economists argue that the Fed may have kept rates too high for too long, potentially hindering the job market’s natural normalization. With the Federal Funds rate at a 22-year high of 5.25% and 5.5% for the past 12 months, companies are struggling under tight credit conditions and scaling back expansion plans.
Traders are anticipating a September cut, with the odds of a year-end Federal Funds rate of between 4.5% and 4.75% rising to 64%, according to CME Group’s FedWatch tool. Benchmark 10-year Treasury note yields have fallen below 4% for the first time since February, while rate-sensitive 2-year notes hit a six-month low of 4.209%. Ian Shepherdson of Pantheon Macroeconomics foresees a 0.25-percentage-point rate cut in September, followed by 0.5-point reductions in November and December.
“The Fed has been too slow in recognizing that the labor market is cooling and that high inflation is yesterday’s problem,” he said.
