The labor market has remained surprisingly strong over the past year, but with fewer jobs opening up and increasing numbers of people remaining on unemployment insurance rolls, Federal Reserve officials have begun looking for cracks.
Central bankers have recently begun to say clearly that if the labor market weakens unexpectedly, they could cut interest rates, a slight shift in their stance after years in which they worked to cool the economy and rebalance a buoyant labor market.
Policymakers have left interest rates at 5.3% since July 2023, a decades-high that is making it more expensive to get a mortgage or carry a credit card balance. That monetary policy is slowly eating into demand across the economy, with the goal of keeping rapid inflation under control.
But as inflation cools, Fed officials have made clear they are trying to strike a careful balance: They want to make sure inflation is under control, but they want to keep the labor market from spiraling out of control. Given that, policymakers have signaled over the past month that they would react to a sudden weakening in the labor market by cutting borrowing costs.
The Fed would like to see more lower inflation data “like we’ve been seeing recently” before cutting rates, Fed Chairman Jerome H. Powell said during a speech this week. “We would also like to see the labor market remain strong. We’ve said that if we were to see the labor market weaken unexpectedly, that’s also something that might require a reaction.”
That’s why the jobs reports are likely to be a key reference point for central bankers and Wall Street investors, who are eager to see what the Fed does next.
For years, the Federal Reserve has been watching the labor market for a different reason.
Officials feared that if conditions in the labor market remained too tight for too long, with employers struggling to hire and paying ever-higher wages to attract workers, that could help keep inflation running faster than usual. That’s because companies with higher labor costs would likely charge more to protect profits, and workers who earned more would likely spend more, boosting continued demand.
But recently, job openings have declined and wage growth has slowed, signaling that the labor market is cooling and that has caught the attention of the Federal Reserve.
“Right now, we have a good labor market, but not a vibrant one,” said Mary C. Daly, president of the Federal Reserve Bank of San Francisco, in a recent speech. “Future slowdowns in the labor market could translate into higher unemployment as businesses need to adjust not only job openings but also actual jobs.”
The unemployment rate has risen slightly this year, and policymakers are watching carefully for a sharper rise. Research shows that a sudden, sharp increase in unemployment is a sign of a recession, a rule of thumb laid out by economist Claudia Sahm and often referred to as the “Sahm rule.”
