The labor market data for July was weaker than expected. While 73,000 payrolls were added and the unemployment rate came in at 4.2%, underlying details were less encouraging. Sharp downward revisions to the prior two months brought the three-month average payroll gain down to just 35,000.
Most job gains were concentrated in education and healthcare, and excluding those sectors, private payrolls have actually declined by an average of 15,000 per month over the past three months. Additionally, the foreign-born labor force participation rate fell again, suggesting that immigration trends are weighing on employment. While it’s important not to overreact to a single report, these developments point to rising downside risks for growth.
Implications for the Fed
This evolving macro backdrop presents a challenge for the Federal Reserve. A weakening labor market alongside inflation pressures complicates the Fed’s dual mandate. At the Federal Open Market Committee’s (FOMC) post-meeting press conference, Federal Reserve Chair Jerome Powell emphasized the unemployment rate as a key metric for assessing full employment.
As long as slower job growth is matched by reduced labor supply, the Fed may still view its employment mandate as intact. Therefore, we do not believe the labor data significantly shifts the Fed’s perceived balance between inflation and employment risks—especially with inflation expected to rise further above its target in the upcoming months.
Implications for Financial Markets
Market expectations for the Fed policy path have shifted. Prior to Friday’s payrolls report, markets were pricing in a 40% chance of a rate cut in September. That probability has now surged to around 90%, indicating that investors are increasingly focused on growth risks rather than inflation surprises.
This shift could lead to heightened volatility in fixed income markets, particularly as there are several major events ahead of the meeting that could reshape expectations—including two Consumer Price Index prints, another employment report and the Jackson Hole symposium. We believe that policymakers would prefer a more balanced expectation for a potential rate cut in September to allow for greater policy flexibility, which could be reinforced through upcoming Fed speak.
Equity markets, which have rallied strongly, may be vulnerable to a pullback. Inflation concerns that prompt a hawkish repricing of Fed policy could be a key risk. At the same time, the equity losses following the U.S. jobs data show that a dovish repricing can also be unfavorable if it’s driven by concerns on economic resilience that is supporting corporate earnings growth.
Finally, while the macro backdrop is important, we also note that the tech sector remains a dominant force in U.S. equity performance. To the extent that changes in the economic landscape do not disrupt some of the structural tech growth drivers, we could see lower impacts than in other areas such as fixed income markets.
What We’ll Be Watching
We expect plenty of Fed speakers to hit the tape in the coming days to provide further guidance. The most recent FOMC meeting was notable for featuring two dissenting votes—something not seen since the 1990s—suggesting we should be prepared for a diversity of views.
One of the central questions for investors and the FOMC is whether growth concerns will outweigh tariff-induced inflation. While the economic calendar is light in the coming week, incoming Purchasing Managers’ Index data and jobless claims will be important indicators. Additionally, U.S. President Donald Trump’s announcement that he is firing the commissioner of the Bureau of Labor Statistics raises concerns about the independence of labor data. In light of this, we will be paying close attention to alternative indicators such as jobless claims, third-party data sources, and private surveys.
Finally, despite this week’s trade developments, the tariff story is far from over. We expect continued updates on U.S.-China negotiations, new sector-specific tariffs, and ongoing negotiations with countries that missed the latest trade deadline, including India and Canada.
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