The US job market is slowing, easing pressure on the Federal Reserve's push to raise interest rates to tackle inflation.
Employment gains in August dropped to 187,000, well below the average of 271,000 over the previous 12 months, according to the latest Bureau of Labor Statistics data. Unemployment also rose as more people reentered the labor force, while employers reported lower demand for new labor in July.
"It's an extremely welcome development," said Yung-Yu Ma, chief investment officer at BMO Wealth Management. "This allows the labor market to 'cool' and also adds to potential economic growth at the same time."
Taken together, the latest data points show one of the most persistent challenges to the Fed’s fight against inflation is fading as tighter monetary policy has its intended effect. The cooldown also means one of the most aggressive rate-hiking cycles in central bank history may have little room left to run.
Rising unemployment, downward revisions
A gain of 736,000 in the labor force to 167.8 million also contributed to the higher unemployment rate reported in August. Some 514,000 more people reported being out of work during the month, pushing the unemployment rate up by 0.3 percentage point to 3.8%. The jump in the labor force size also pushed up labor force participation — how many working-age people have a job or are seeking one — by 0.2 percentage point to 62.8%.
Among all sectors, private education and health services posted the greatest employment gains for the month, at 102,000, followed by 40,000 jobs added in the leisure and hospitality sector and 22,000 in construction.
The sectors with the largest number of jobs lost in August included trade, transportation and utilities with a total of 20,000 fewer jobs and the information sector with 15,000 fewer jobs.
The latest data also revealed sizeable downward revisions to June and July's employment numbers. The total nonfarm payroll employment gain for June was down by 80,000 to 105,000, while July was lowered by 30,000 to 157,000 added jobs.
Although revisions are not uncommon given late respondents and other factors, their magnitude reveals softer-than-expected job growth, even amid a tight labor market.
"These changes and the benchmark revisions for earlier in 2023 indicate that the pace of hiring this year was not as strong as previously reported," said Ben Ayers, senior economist at Nationwide Economics. "Still, average job growth through August is 235,500 — a strong pace given how tight the labor market is and suggestive that demand for workers is still elevated. But the revisions do provide the Fed a bit more cover to say that the tightening cycle is being successful in slowing the economy."
Easing job growth, combined with other indications of a slowing economy, could suffice to discourage the Fed from implementing additional interest rate hikes. Still, Fed Chairman Jerome Powell has cautioned repeatedly that the central bank may have more rate rises in store.
"Additional evidence of persistently above-trend [job] growth could put further progress on inflation at risk and could warrant further tightening of monetary policy," Powell said Aug. 25 during the Federal Reserve Bank of Kansas City's annual economic symposium.
Federal Reserve target
To sustainably reach the Fed's 2% inflation target, Powell said a period of below-trend economic growth and softening labor market conditions would be required.
Current indicators point to the US avoiding a recession. Still, employment gains need to slow to 100,000 or less per month on average for the next year to sustainably attain the inflation target, said Chris Varvares, co-head of US economics at S&P Global Market Intelligence.
"The labor market is already so tight that wage gains are running at a pace that is simply inconsistent with the Fed being able to achieve its inflation target," said Varvares.
The latest reading of the Fed's preferred inflation gauge — personal consumption expenditures excluding food and energy — showed prices rising by 4.2% year over year in July, more than double officials' target. Similar price data for August will be released at the end of September.
If the labor force participation rate continues to rise, employment could increase at a rate higher than 100,000 per month, though Varvares said the rate was likely nearing the extent of its post-COVID-19 recovery.
While Powell closed his speech by saying the Fed was still "navigating by the stars in cloudy skies," the newest job openings data showed evidence of further softening and could be the final push needed for July's interest rate hike to be the last in 2023.
The 8.8 million open jobs in July, while historically high, was lower than economists' predictions of 9.6 million, according to consensus forecasts compiled by Econoday. Some 91% of investors expect the Federal Open Market Committee to hold the benchmark federal funds rate at its current level at the next meeting later in September, according to the CME FedWatch Tool, which measures market sentiment based on futures trading.
Still, other factors may prevent additional softening in the labor market, said Varvares. Market Intelligence forecasts US GDP growth of 4% for the current quarter.
"At that pace, employment will continue to grow faster than new workers will enter — 4% GDP growth does not suggest much further easing in the labor market," said Varvares. "The implication is either the Fed is not done [with rate hikes] or the markets will lead to a further tightening of financial conditions on their own."