Labor Day: Is the job market cracking?

The unemployment rate reached 4.3 per cent in July, nearly a full percentage point above its low for the cycle. America's jobs market therefore arrives at Labor Day in an uncomfortable spot. The question is whether it is cooling in an orderly way or starting to break down.

A slow climb from the low

The low came in 2023, when unemployment touched 3.4 per cent, its lowest since the late 1960s. Since then it has crept up month by month rather than jumping, which is why it was easy to dismiss for so long. July's report changed the tone. Payrolls rose by only 114,000, and the rise in the jobless rate was enough to trigger the Sahm rule, a recession signal that has fired in every American downturn since 1970.

The revision published last month made the backdrop gloomier. The Bureau of Labor Statistics said its preliminary benchmark showed that payrolls in the year to March had been overstated by hundreds of thousands of jobs. The labour market that looked resilient through the winter was already softer than it seemed.

Workers up, openings down

Optimists say unemployment is rising because more people are looking for work, thanks to immigration and to workers returning to the labour force. Pessimists point out that job openings have tumbled and hiring has slowed to a crawl. Payrolls at temporary help agencies, a reliable leading indicator, are shrinking outright. When demand for labour falls while borrowing is expensive, employment can turn negative quickly.

Both camps have evidence. Net immigration surged in 2022 and 2023, adding workers faster than employers could absorb them, and participation among people in their prime working years has climbed above its pre-pandemic level. A rise in unemployment driven by more people wanting jobs is relatively benign. The demand side looks worse: job openings have fallen from a peak of about 12 million in early 2022 to around 8 million, and temporary-help employment has been shrinking since early 2022.

So far the optimists' model has held up. In 2022 Fed governor Christopher Waller argued that vacancies could fall a long way without much rise in unemployment, because employers were starting from so many unfilled posts, and through 2023 that is broadly what happened. The cushion is now much thinner. With openings far closer to their pre-pandemic level, further cuts in demand fall on existing jobs rather than on advertisements nobody was going to fill.

Where the jobs still are

The composition of hiring is another warning sign. A large share of the jobs added over the past year has come from health care, social assistance and government, sectors driven by demographics and public budgets rather than by the business cycle. Hiring in industries that respond to interest rates and consumer demand, such as manufacturing, retail and business services, has been far weaker. An expansion that rests on hospitals and local government is more fragile than the headline total suggests, since those sectors cannot absorb workers laid off elsewhere at the speed a downturn would require.

Pay tells a similar story. Average hourly earnings are rising at about 3.6 per cent a year, down from over five per cent at the peak, which is good news for the Fed's inflation fight but also a sign that employers no longer need to bid for staff.

How a slowdown feeds itself

The danger lies in the sequence. Firms that stop hiring first let attrition shrink their workforce; if sales then weaken, they move to layoffs, and laid-off workers cut their spending, which weakens sales further. High borrowing costs make each step harder to reverse, because companies cannot cheaply finance a wait for better times. That is why the Sahm rule works: historically, a half-point rise in unemployment has rarely stopped there.

The case for calm

Layoffs remain low, and weekly claims for unemployment benefits are near levels that would have looked healthy before the pandemic. Second-quarter growth was revised up last week, and consumer spending has held firm. Part of the rise in unemployment reflects new entrants to the labour force rather than lost jobs. If the August report, due on 6 September, shows the jobless rate stabilising, the benign reading will gain ground.

Corporate balance sheets also argue against a sudden collapse. Many companies refinanced their debt at low fixed rates in 2020 and 2021 and have not yet had to roll it over at today's costs, and profit margins remain wide by historical standards. That gives firms room to keep staff through a soft patch rather than cutting at the first sign of weaker sales.

The Fed has turned

Jerome Powell has already signalled a change of course. At Jackson Hole on 23 August he said the time had come for policy to adjust and that the Fed did not want to see further cooling in the labour market. The meeting on 17 and 18 September will decide how fast it moves. A quarter-point cut would still leave the policy rate at 5 to 5.25 per cent, well above inflation, so a larger first step has a strong case if the August figures disappoint.

New entrants and workers in cyclical industries such as manufacturing and construction, where hiring freezes bite first, have the most to lose from delay. The labour market is at a turning point. Without prompt rate cuts, this summer's gentle cooling could become a slump that feeds on itself by the winter. Should the August report show unemployment at 4.3 per cent or higher, expect the Fed to open with a half-point cut this month, with job-seekers and young workers the ones who most need it to work.