With the labor market deteriorating, a rate cut becomes all but certain

A rate cut by the Federal Reserve at its next meeting on Sept. 17 became all but certain after the August jobs report showed a slowing demand for workers.

The slow hire, slow fire economy that has been the story of the labor market in recent months remained intact as it added 22,000 jobs in August.

The August data, combined with a downward revision of 21,000 jobs in June and July, shows total employment increased by only 1,000 jobs over the past three months, compared to what was originally estimated.

Deterioration in the domestic labor market is a function of cyclical factors such as trade and immigration policies as well as structural factors like the retirement of baby boomers, all of which are constraining the labor supply.

We expect a series of weak jobs reports throughout the remainder of the year that should hover near the 50,000 monthly breakeven level necessary to keep employment conditions stable. Worse still, June’s data was revised down to show a decline of 13,000 net jobs, the first net loss since December 2020.

With hiring slowing to an average of 29,000 over the past three months, conditions are ripe for a bit of risk management by the Fed, which is poised to reduce its policy rate by 25 basis points on Sept. 17.

The impact of tariffs on hiring is undeniable—not only in the August numbers but throughout the May−August period, when tariffs pushed economic uncertainty to the highest level in years.

Not surprisingly, the goods sector has been hit hardest by tariffs, posting four straight months of declines. Manufacturing, which was supposed to benefit from restrictive trade policies, instead slipped into reverse as supply chain uncertainty deepened.

Meanwhile, the unemployment rate ticked up to 4.3%, with the number of unemployed workers reaching the highest level since 2021.

Policy implications

If this data had been available to the Fed back in June, the likelihood of a rate cut in July would have risen significantly. The August report should all but seal the deal for a September cut—unless this week’s consumer price index delivers a major upside surprise.

One will hear talk of a 50-basis-point cut, which we think is premature. It would take a large downside surprise in the producer price index and consumer price index for that to happen. And based on our forecast, that is unlikely.

We expect inflation to edge higher in August, but the increase will most likely not be strong enough to offset the weak labor market data. September’s cut will be less about stimulating growth and more about managing risk.

Beyond September, though, the Fed’s challenge becomes far more complex if job gains remain tepid while inflation stays elevated or increases. That dynamic would make a sustained series of cuts far from guaranteed.

A recession?

While job growth typically turns negative ahead of a recession, we don’t think that is what’s happening now.

Current labor market dynamics are a function of both cyclical and structural factors, with trade and immigration policies at the center.

Pervasive uncertainty driven by these trade and immigration policies is the primary impetus behind reduced demand for workers. At the same time, supply-side factors driven by restrictive immigration policies and demographic changes will continue to constrain the ability of firms to find workers.

We expect growth and hiring to reaccelerate as the combination of interest rate cuts, tax cuts and full expensing of business investment bolsters demand for labor the rest of this year and into the next. We do not expect the economy to slip into a recession. 

The data

Goods sector employment fell by 25,000 in August, with all subcomponents showing declines. Manufacturing jobs fell by 12,000, while mining and construction dropped by 6,000 and 7,000, respectively.

Trade and transport added 2,000 jobs, while retail trade added 11,000. The information sector shed 5,000 jobs, the financial sector lost 3,000, and professional and business services lost 7,000.

The services sector continued to be a bright spot, rising by 63,000 jobs in August. Most of the increase came from the two subsectors: education and health services, and leisure and hospitality, which increased by 46,000 and 28,000 positions, respectively.

Government jobs declined in August, falling by 16,000, driven by cuts at the federal and state levels.

Average hourly earnings increased by 0.3% on the month and by 3.7% from a year ago. Total private hours worked remained unchanged at 34.2 per week.

The labor force participation rate increased to 62.3%, while the employment-to-population ratio increased to 59.6%.