Job creation falls short of expectations in July

The economy’s continued expansion fueled solid job creation in July, albeit fewer than had been anticipated heading into today’s release of the July Employment Situation report. Despite falling short of forecasts, the economy produced enough new jobs to tip the unemployment rate back to 3.5%, very near its tightest rate in decades.

Nonfarm payrolls rose by 187,000 in July – very much in line with the revised June tally of 185,000. That monthly gain fell short of forecasts of around 200,000 and was a bit of a surprise given the stronger-than-expected ADP jobs report earlier this week. On top of that, revisions reflected in the July report shaved 49,000 off the prior two monthly increases, trimming the net gain for the month to a more pedestrian 138,000. Moreover, the 3-month average increase of 218,000 is still far from anything signaling weakness in the jobs market.

Broadly speaking, the pace of job creation is now much closer to trend growth for the U.S. economy than anything that has been generated since before 2020. Against a backdrop of a solid but unspectacular GDP gain of 2.4% for the last quarter, it’s in line with what one might expect.

In a different environment – against the backdrop of stable inflation and a sanguine Federal Reserve – today’s report might prompt high fives. Instead, it paints a labor market picture that complicates the Fed’s near-term decisions about the execution of monetary policy. Inflation has rapidly receded in recent months, but the path back to the central bank’s 2% target looks more difficult from here.

While there’s clear evidence of a cooling of the labor market, conditions are still simmering. Jobs are still being created at a pace that will keep unemployment near half-century lows; wage growth of 4.4% over the past year is still high compared to the pre-COVID norm.

That leaves the Fed with a need to balance analysis and introspection in their decision-making – both data-dependent and pragmatic. Without a greater loosening of labor markets in the form of slower (if not negative) job creation and an uptick in the unemployment rate, can wage growth moderate sufficiently for inflation to return to an acceptable range? The Fed’s forecasts continue to suggest that they are looking for unemployment to rise meaningfully off its current low for inflation to gradually normalize over the next few years.

That leads to the second question, which is whether or not the Fed has already done enough or is close to calling it a wrap on the current tightening cycle. How much of the impact of prior rate hikes has yet to be absorbed? And how willing are policymakers to err to the side of doing too little in an effort to cool the economy without crashing it? These are all questions that policymakers will be grappling with in the coming months.

The bottom line? Despite the resurgence in GDP growth in recent months, a moderate slowdown in the pace of job creation is directionally positive for policymakers looking for evidence of progress in normalizing labor market conditions and inflation. A much more pronounced slowdown will be needed to move the needle on unemployment, though. It’s likely to occur even in the absence of further Fed tightening as the full impact of cumulative rate hikes is absorbed. How long that might take – and whether or not Fed policymakers can wait that long before taking further action – remains to be seen. That raises the stakes for incoming data on inflation and labor conditions over the next month, setting the stage for their next policy meeting.