The labor market has been surprisingly strong over the past year, but as unfilled job openings fall and the number of people remaining on unemployment insurance rolls rises, Federal Reserve officials are growing wary of cracks.
The central bank recently began explicitly saying it could cut interest rates if the labor market unexpectedly softens, a slight shift from its long-standing efforts to cool the economy and rebalance a booming jobs market.
Policy makers have kept interest rates steady at 5.3% since July 2023, the highest level in decades and making it more expensive to take out a mortgage or carry a credit card balance.The policy setting has the goal of completely taming fast inflation, which has been gradually weighing on demand across the economy.
But as inflation has subsided, Fed officials have made it clear they are trying to strike a careful balance: They want to keep inflation in check but avoid disrupting the job market. As such, policymakers have signaled over the past month that they would respond to a sharp weakening in the labor market with sharp cuts in borrowing costs.
Fed Chairman Jerome H. Powell said in a speech this week that the Fed expects to see more subdued inflation data “of the kind we have seen recently” before cutting rates. “We also want to see continued strength in the labor market. We have said that if we see the labor market weakening unexpectedly, we may need to respond.”
As a result, the employment data is likely to be a key reference point for central bankers and Wall Street investors who are eager to see what the Fed will do next.
For years, the Fed has been monitoring the job market for other reasons.
Officials had worried that if the job market remained tight for an extended period of time, employers would struggle to recruit and wages would continue to rise, leading to inflation running at a faster pace than normal, as companies with higher labor costs would likely raise rates to protect profits and workers who earn more would likely increase spending, encouraging continued demand.
But recently, job openings have been falling and wage growth has slowed, signaling the job market's strength is cooling — and that has caught the Fed's attention.
“Right now, the labor market is strong, but it's not overheating,” Federal Reserve Bank of San Francisco President Mary C. Daly said in a recent speech. “A slowdown in the labor market in the future could lead to higher unemployment as businesses have to adjust their actual hiring, not just their vacancies.”
The unemployment rate has risen slightly this year, and officials are wary of a more pronounced movement. Research suggests that a sudden, significant increase in the unemployment rate is a sign of an economic downturn, a rule of thumb coined by economist Claudia Tham, also known as the “Tham rule.”