Downside risks to the labor market are becoming more of a concern for Fed policymakers, with some open to a July interest rate cut.
It’s been three years now since people began worrying that high interest rates would push the US economy into recession, so some skepticism is in order whenever a spell of soft economic data draws fresh concerns. A growing body of evidence, however, suggests that this time really is different. The unusual supports that held up the labor market following the pandemic are now largely gone, inviting more typical recessionary risks if the economy weakens from here.
The most concerning recent trend is the uptick in the number of people collecting unemployment benefits, which has accelerated over the past couple of months at the quickest pace since early 2024. This, combined with the softening in underlying inflation, has prompted a rethink from some members of the Federal Reserve’s rate-setting committee on how quickly to resume policy easing to support the labor market.
Over the past week, two Fed governors — Christopher Waller and Michelle Bowman — have said that downside risks to the labor market are a concern that may warrant an interest rate reduction as soon as the central bank’s July meeting. Chair Jerome Powell did not endorse that specific scenario in testimony to Congress on Tuesday, but he said that it was one of many possible outcomes. Markets are now priced for around a 20% chance of a cut next month.
With Powell leaving his options open, Waller’s comments are significant given he correctly argued against recession fears in the summer of 2022, when the number of job openings relative to the number of unemployed workers was at nearly double its pre-pandemic level. That left room for a cooling without unemployment rising much. Now, however, the job openings-to-unemployment ratio is back at levels last seen in late 2018. Data such as the increasing unemployment among college graduates are “starting to make me a little worried,” Waller said in a CNBC interview last week, adding:
I’m all in favor of saying maybe we should start thinking about cutting the policy rate at the next meeting, because we don’t want to wait till the job market tanks before we start cutting the policy rate.
The labor market for young and white-collar workers has been sluggish since at least the latter part of 2023, driven by a normalization after the over-hiring of the pandemic boom. More recently, companies have begun looking for ways to use artificial intelligence rather than hiring to drive growth. There seems to be a growing sense among companies large and small that what’s impressive and innovative to investors now is using AI to scale teams and companies with as few workers as possible. The extent to which this is feasible remains to be seen, but the vibe shift suggests we’re unlikely to see a corporate hiring boom in the near-term despite the hundreds of billions of dollars being pumped into AI.
We got the latest evidence of this with news that Microsoft Corp. plans to cut 6,000 jobs on the heels of a prior round of 6,000 layoffs. It’s notable that Microsoft is making these changes as executives plan for the next fiscal year, which begins July 1 for the company. As I’ve written previously, there’s a reasonable possibility that the typical fiscal year-end of Dec. 31 brings further waves of layoffs when companies go through their annual planning cycles.
Housing and government also pose risks to employment now in a way that they didn’t a year ago. Rising resale housing inventory in the South and West is putting downward pressure on construction activity and homebuilder profit margins, often a prelude to layoffs. Government employment, an important source of job growth in 2023 and 2024, has been flat since January given the Trump administration’s efficiency drive and budget crunches at the state and local government level.
These emergent but inconclusive labor market risks pose a challenge for the Fed, which is dealing with multiple sources of inflation uncertainty, too, from tariffs to the tax legislation going through Congress and conflicts in energy-producing regions. It’s no surprise then that Powell on Tuesday reminded senators of the need for caution with consumers still hurting from their recent experience with inflation. “We haven’t fully restored price stability, and another shock, we have to be careful if there’s a meaningfully large and sustained inflation shock,” he said.
Ultimately, though, it’s downside risks from the labor and housing markets that are likely to be what’s more persistent. The Conference Board’s gauge of confidence unexpectedly declined in June, according to data Tuesday, with the share of consumers that said jobs were plentiful dropping to the smallest in more than four years. Also on Tuesday, the S&P CoreLogic Case-Shiller home price indices showed a second month of declines in April for the 20 metros tracked from the previous month.
It’s understandable that Fed policymakers want a little more time to get their arms around these short-term inflation risks, but they can’t allow the labor market to deteriorate much more than it already has.
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