Employment data supports the Federal Reserve's decision to maintain its current policy stance, as per a recent research report. For the Fed, a stable labor market serves as a foundational assumption for shifting its focus and decision-making toward inflation. On this basis, differences in tolerance for inflation have led to increased internal divisions within the Fed. However, the continued cooling of employment over the past two months, shifting to a "weak but not collapsing" state, supports the rationale for maintaining the current stance, waiting for and observing further declines in inflation. This also helps to bridge internal disagreements.
Currently, there is a tendency to believe the Fed can keep interest rates unchanged this year, as the rationale for a "preventive rate hike" similar to 1997 is not sufficiently strong. The key points from the research are as follows.
Summary of July Nonfarm Payroll Data
First, the number of new nonfarm payroll jobs was -23,000, against an expectation of 80,000, with the previous two months revised down by a combined 103,000. Job growth was mainly concentrated in education and health services (+25,000, previous +54,000), construction (+22,000, previous +5,000), and professional and business services (+18,000, previous +34,000). Four industries experienced job contraction: government (-53,000, previous -10,000), leisure and hospitality (-40,000, previous -43,000), retail, and financial activities.
Second, the unemployment rate fell to 4.1% from 4.2%, against an expectation of 4.2%. The labor force participation rate dropped to 61.4% from 61.5%, below the expected 61.6%. According to the household survey, the labor force decreased by 264,000, employment fell by 87,000, unemployment dropped by 178,000, and the number of people not in the labor force increased by 381,000.
Third, average hourly earnings in the private sector rose 0.1% month-over-month, below the expected 0.3% and the previous 0.3%. The year-over-year growth rate was 3.2%, below the expected 3.5% and the previous 3.4%. The average weekly hours worked remained unchanged at 34.3 hours. Weekly earnings increased 0.1% month-over-month.
Fourth, market expectations for rate hikes within the year cooled. The probability of a September rate hike, as priced by the federal funds futures market, fell from 57% to 44%, and the expected number of rate cuts for the year dropped from 1.35 to 1.13.
Comprehensive Cooling in Employment Data
First, from a total perspective, the unexpected negative turn in new nonfarm payrolls, combined with significant downward revisions to the previous two months' data, paints a clear picture. The average new nonfarm payrolls over the last three months fell from 77,000 to 20,000, dropping to the lower end of the range estimated by overseas institutions as the breakeven level for job growth. Structurally, industry-level employment was also disappointing. While the current month's new nonfarm payrolls were significantly dragged down by local government education departments (-50,000, previous -11,600), private sector payrolls were also weak. Employment in leisure and hospitality, retail, and financial activities contracted. The weakness in the first two sectors may be related to the fading of temporary hiring demand associated with the World Cup. Only construction, driven by AI-related demand, showed relatively strong job growth.
Second, the unemployment rate fell more than expected, but the primary reason was not "more people finding jobs," but rather "more people leaving the labor force." Although the participation rate for the prime-age group (25-54 years old) saw a slight increase, participation rates for younger and older workers continued to decline significantly. The labor force participation rate has been falling consistently this year, diminishing the unemployment rate's effectiveness as an indicator of labor market health. A more reliable metric is the employment-to-population ratio, which has declined by about 0.8 percentage points this year, compared to a decline of only 0.3 percentage points for the whole of last year.
Third, consistent with the weak employment growth, the month-over-month growth in average hourly earnings was below expectations, and the year-over-year growth rate fell to its lowest level since June 2021. The unanchoring of long-term inflation expectations and the wage-price spiral are the core transmission channels for converting temporary price shocks into persistent inflation. Currently, long-term inflation expectations appear stable, and wage growth rates are continuing to decline, suggesting a low risk of endogenous second-round inflation.
Employment Data Supports the Fed in Maintaining Its Current Stance
The continued comprehensive cooling of employment in July reinforces the earlier assessment: the significant rebound in employment since the start of the year was not sustainable, and the narrative of an overheating labor market has been further disproven. For the Fed, a stable labor market is the foundational assumption for shifting its focus and decision-making toward inflation. On this basis, differences in tolerance for inflation have led to increased internal divisions. The continued cooling of the labor market over the past two months, shifting to a "weak but not collapsing" state, supports the rationale for maintaining the current stance, waiting for and observing further declines in inflation. This also helps to bridge internal disagreements. Currently, the view leans toward the Fed keeping interest rates unchanged this year, as the case for a "preventive rate hike" similar to 1997 is not sufficiently strong.
For the market, regarding U.S. equities, reduced pressure for rate hikes means the risk of macroeconomic policy headwinds continues to recede, leading to a marginal improvement in macro risk appetite. For U.S. Treasuries, this helps to alleviate upward pressure on real interest rates. If inflation does not exceed expectations in the future, short-term and long-term Treasury yields may already be in a phase of cyclical peaks, and the probability of further significant increases is relatively low.
Risk warnings include the uncertainty of geopolitical conflicts and the uncertainty of the AI industry trend.
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