US employment report shows labour demand stalling

Today’s US employment report for July showed the headline payrolls number printing at 114k, substantially below the expected 175k reading, and with a downwards revision of 27k made to the June report. The private payrolls number fared even worse, printing at just 97k – the lowest reading since March 2023 – and if healthcare and education are stripped out, showed an increase of just 40k, leaving the 3-mth average growth rate rising at its slowest pace since the Covid pandemic. The headline rate of unemployment rose by 0.2% to 4.3%, the biggest jump since February, and which means the Sahm Rule (which says that when the average jobless rate over 3 months is 0.5% above the 12-mth low, a recession is coming) has probably been triggered. And worryingly, the report shows the slowdown in hiring to be broad-based and not attributable to any single factors, such as the weather (although Hurricane Beryl is likely to have influenced the numbers). As such, it is hard to conclude anything other than it is the Fed’s monetary tightening that is responsible for this downturn, with the lagged impact of the current high level of interest rates – and a real interest rate of some 2.5% - finally expressing themselves via a deteriorating labour market.

For the Fed, it must surely now be confident that the downturn in the labour market it was seeking has finally arrived. Indeed, today’s report very much ties in with the growing body of survey evidence that have been pointing to a slowdown in hiring intentions and rising job layoffs for some time. And this suggests that the labour market looks set to slow further going forward.

The hiring intentions component of the regular NFIB survey has been pointing for some time to a slowdown in private payrolls growth, while survey evidence elsewhere is also pointing to a weakening in labour demand. Meanwhile, the upwards trend in jobless claims is continuing, and unsurprisingly coinciding with households reporting that the risk of job losses and unemployment is rising. While the high US real interest rate is seeing corporates increasingly being required to implement cost-cutting measures to offset the very high cost of credit, a major component of which is layoffs. And with little growth now being seen in state and local government revenues, there is little opportunity for the official sector to take up any emerging employment slack. As such, even though the Fed had been waiting for hard evidence to show that the labour market was slowing, the lagged nature of monetary policy, and the fact it chose to ignore all the above warning signs, now leaves it looking very much behind the curve. It means that a rapid lowering in interest rates is now looking likely.

The crumb of comfort for the Fed is that the increase in the unemployment rate has been driven more by rapid growth in the workforce and a slower pace of employment growth, rather than by job layoffs per se. As such, it is much too soon to conclude that the US economy is about to fall into a recession. But it is hard not to conclude that the labour market is no longer tight. And with the rate of unemployment now 0.1% above the Fed’s estimate of the long-term natural rate of unemployment – 4.2% - any further increases in the rate would be consistent with pricing pressures falling below the 2% CPI target. It is no surprise that Powell had recently been highlighting growing concerns among some FOMC members about the risks to the labour market of delaying too long cuts in interest rates, including lowering then too timidly thereafter.

The reaction of the markets to today's report has been quite damming for the Fed. Whereas in the past, softer data would see equities rally on the expectation that inflation was coming down and interest rate cuts were on the horizon, the fact that equities have reacted so negatively today shows the thinking is that the Fed is already behind the curve and should have been cutting rates already. Even though we have two CPI reports between now and the September Fed meeting, the market has effectively discounted their potential impact, with pricing now showing the question is whether we get a 25bps or 50bps interest rate cut.

Just two days ago Powell said "I would not like to see material further cooling in the labor market. If we see something that looks like a more significant downturn, that would be something that we would ... have the intention of responding to.” How he is probably wishing the July FOMC meeting came immediate after today’s employment report rather than before it.