The labor market has remained surprisingly active over the past year, but with fewer job openings and more people on unemployment insurance rolls, Federal Reserve officials are starting to watch for cracks.
Central bankers have recently begun to say explicitly that if the labor market unexpectedly weakens, they could cut interest rates — a slight shift in their stance after years of working to cool the economy and bring a hot labor market back into balance.
Policymakers have left interest rates at 5.3% since July 2023, the highest level in decades and making it more expensive to get a mortgage or carry a credit card balance. This policy stance is slowly affecting demand across the economy, with the goal of getting rapid inflation under control.
But as inflation eases, Fed officials have made clear they are trying to strike a delicate balance: They want to make sure inflation is under control, but they want to avoid upending the labor market. Given that, policymakers have signaled over the past month that they will respond to sudden weakness in the labor market by lowering borrowing costs.
Federal Reserve Chairman Jerome Powell said in a speech this week that the Fed would like to see more soft inflation data “like we’ve seen recently” before cutting interest rates. “We also want to see the labor market remain strong. We’ve said that if we see the labor market weaken unexpectedly, that’s also something that could prompt a response.”
That’s why the employment reports are likely to be a key reference point for central bankers and Wall Street investors eager to see what the Fed will do next.
For many years, the Fed has been watching the labor market for a different reason.
Officials have been concerned that if labor market conditions remain too tight for too long, with employers struggling to hire and paying ever-increasing wages to attract workers, it could help keep inflation running faster than usual. That’s because companies with higher labor costs are likely to charge more to protect profits, and workers who earn more are likely to spend more, fueling continued demand.
But recently, job openings have fallen and wage growth has slowed, suggesting that the labor market is cooling off after a simmering slump. That has caught the Federal Reserve’s attention.
“At this point, we have a good labor market, but it’s not a frothy market,” said Mary C. Daly, president of the Federal Reserve Bank of San Francisco. recent speech“A slower labor market in the future could translate into higher unemployment rates, as companies need to adjust not just job openings but actual jobs.”
The unemployment rate has ticked up slightly this year, and officials are watching cautiously for a more pronounced move. Research shows that a sudden, noticeable rise in unemployment is a sign of recession—a By experience Developed by economist Claudia Sahm and often referred to as the “Sahm Rule.”
