Recent inflation data came in roughly in line with expectations, showing year-on-year price increases continuing to slow as investors debate when and how far the Federal Reserve will cut interest rates.
While inflation was the reason the US Federal Reserve raised interest rates, the central bank’s other mandate, maximum employment, is now moving to the forefront amid the debate over rate cuts.
“these [job] “The payrolls numbers are really where the action is going to be over the next couple of months,” Nathan Sheets, global economist at Citi, told Yahoo Finance. “That’s where the Fed is going to be very focused.”
Economists argue that with inflation now below the Fed’s 2% target on a three-month basis, the most worrying trend in economic data is in the labor market, where the unemployment rate has been steadily rising and monthly job creation has fallen.
“We are at a turning point now,” Nicholas Brooks, head of economics and investment research at ICG, told Yahoo Finance. “While I think most of the focus over the last six months and beyond has been on inflation numbers and bringing them down again, now that the headline is [inflation] Number and nucleus [inflation] “The numbers are coming back down…to levels where the Fed feels more comfortable, and I think the focus is now more on the growth data.”
The weak July jobs report helped shift the focus to a slowing labor market. The report showed the second-weakest monthly job gains since 2020 and the highest unemployment rate in nearly three years. The report also triggered a popular recession indicator that shows that, historically, recent increases in unemployment tend to pile on themselves as labor market dynamics deteriorate.
While the focus on inflation is not going away, the risks in the labor market are higher than the risks associated with inflation, Mark Zandi, chief economist at Moody’s, told Yahoo Finance.
“The trend line points to higher unemployment and lower inflation,” Zandi said.
If this trend continues, further deterioration in the labor market is more likely to prompt further easing by the Fed than if it were just low inflation that prompted a rate cut, Zandi said.
While the labor market has clearly slowed, economists have found solace in the current dynamics, in which the unemployment rate is rising mainly because more workers are joining the labor force while fewer companies are hiring new workers — not because companies are carrying out mass layoffs.
This puts increasing pressure on the layoff data, which Zandi said will be the “key statistic.”
“Businesses have already pulled back on hiring, so job creation is slowing,” Zandi said. “But fortunately, so far, they haven’t increased layoffs to a significant degree. But if that happens, we’ll be in a different situation. The risk of a recession would be much higher than I currently expect.”
Zandi, who said he currently sees about a 33% chance of a recession in the next 12 months, noted that weekly jobless claims will be a key release to watch when tracking layoffs.
Last week, initial claims for unemployment benefits fell more than expected, giving some relief to markets that had been worried about further signs of deterioration in the U.S. labor market.
The next weekly jobless claims data is due out Thursday morning. Economists expect 235,000 claims, up slightly from the 233,000 claims filed the previous week.
Josh Schaffer is a reporter at Yahoo Finance. You can follow him on X @_Joshshafer.
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