Labor Day: Hiring is strong enough to worry the Fed

The August employment report, landing just before Labor Day, showed an American jobs market in fine health. That was good news for workers and bad news for the Federal Reserve, which now has clear evidence that hiring is running too hot for its comfort.

Good news, wrong audience

Politicians treat strong job growth as something to boast about. Central bankers see it differently. To the Fed, an economy adding hundreds of thousands of jobs a month while inflation runs at 3.4 per cent is a problem waiting to happen. Plentiful work keeps household incomes up, so families can absorb hundred-dollar oil and tariffs on goods in the shops without spending less. That keeps demand strong and prices rising.

The mechanism runs through the pay packet. When jobs are easy to find, workers quit for better-paid positions and employers raise wages to keep staff, and higher labour costs are then passed on in the prices of services, where wages make up most of the cost. Energy and tariff shocks hit goods prices first. A tight labour market is what allows them to spread into services and settle into core inflation.

Warsh needs slack

Chairman Warsh and his colleagues know they cannot bring inflation back under control while the labour market stays this tight. To bring down sticky core inflation, the Fed will have to slow hiring on purpose and open up some slack.

The mandate points the same way. Congress has told the Fed to pursue maximum employment and stable prices, and in most cycles the two goals move together. They diverge after a supply shock, when inflation rises while employment is strong, and the committee must judge which goal is further from target. With employment at or beyond its maximum and inflation well above 2 per cent, the mandate itself tilts the decision towards tightening.

The late 1960s show the risk of leaning the other way. With unemployment low and federal spending rising on the Vietnam war and new social programmes, the Fed kept policy easy for fear of choking off growth, and inflation climbed from below 2 per cent early in the decade to around 6 per cent by its end. That rise laid the foundations for the 1970s, when oil shocks landed on an economy whose inflation expectations were already drifting.

Cooling without layoffs

The optimistic version of this story was tested in 2022 and 2023. When the Fed raised rates sharply, some economists warned that unemployment would have to rise steeply to bring inflation down, while others, including Fed governor Christopher Waller, argued that with job openings unusually high, labour demand could cool mainly through fewer vacancies and fewer quits. Openings did fall a long way while unemployment rose only modestly, and inflation came down. That episode is the best argument that the Fed can open up slack without mass lay-offs.

It may not repeat. The earlier cooling was helped by the healing of pandemic supply chains and a surge of immigration that added workers, and neither force is available now, with immigration restricted and energy supplies disrupted. If vacancies are no longer unusually high, further cooling is more likely to come through hiring freezes and job losses.

Pay data will show whether the tightness is feeding through. Average hourly earnings, the Employment Cost Index and the quits rate measure the same pressure from different angles, and a high quits rate, which shows workers confident enough to leave for better pay, has historically run ahead of wage growth by several months. If quits fall while hiring stays strong, the market may be cooling of its own accord, which would give the Fed room to move slowly.

Who gives back the gains

Slower hiring does not fall evenly. Young people entering the workforce, recent graduates and workers without a degree are usually the first to find openings scarce, because firms freeze recruitment before they cut existing staff. Workers in rate-sensitive industries such as construction, property services and car sales face the earliest pressure, while those in health care and government are more sheltered. Employees who already have jobs keep most of this year's wage gains, and it is the next cohort that pays.

The Fed also watches for the point at which cooling becomes a slump. The Sahm rule, which flags a recession when the three-month average unemployment rate rises half a percentage point above its low of the previous year, has been a reliable warning in past downturns, and a committee tightening into a strong market will be watching it closely.

The political calendar adds tension. A Fed that raises rates into a strong jobs market ahead of the midterm congressional elections in November invites criticism from politicians who see the gains in employment as proof that policy is working. Its independence rests on acting on the data regardless, and a new chair has particular reason to show that early.

What to watch this autumn

The monthly reports on job openings and quits, weekly claims for unemployment benefits and the quarterly Employment Cost Index will show how quickly the market is cooling. The consumer-price reports for services excluding energy will show whether the heat is still reaching prices. On Labor Day 2026 American workers have rarely had it so good, and that is exactly why the Fed is likely to keep raising rates this autumn. The goal is to cool hiring, and some of this year's gains in jobs will probably be given back.