False alarm or impending disaster? Tonight's non-farm payrolls will reveal the answer

Tonight's non-farm payroll data will provide key information, revealing whether the recent rise in the unemployment rate is a one-time fluctuation or the beginning of deeper issues.

The unemployment rate in July saw a significant increase, ending the trend of only slight increases over the past year. If the unemployment rate continues to rise in August, economists may be more concerned that the United States may already be in a recession or approaching the early stages of an economic downturn. However, if the unemployment rate remains unchanged or decreases slightly as expected by economists, the weak data in July may be seen as a false alarm.

This answer will be revealed at a critical moment, as the Federal Reserve is preparing for its first rate cut since the 2020 pandemic.

Federal Reserve officials have made it clear that they will cut rates at the September meeting. Whether the rate cut will be the usual 25 basis points or a larger 50 basis points may depend on the performance of the labor market. Such an important decision relying on one data point is rare.

Julia Coronado, founder of MacroPolicy Perspectives, said from a macro policy perspective: "This is very important. It will set the tone for the Fed, and the Fed's decision will affect global monetary policy and markets." The key is what information the data will show.

In recent months, the U.S. labor market has cooled significantly. Most notably, the unemployment rate rose to 4.3% in July, a significant change from 3.4% in April 2023. This unemployment rate is now higher than pre-pandemic levels, and the recent speed of increase has caught the attention of Federal Reserve officials and labor market economists. Federal Reserve Chairman Powell said in a recent speech:

"We do not want or welcome further cooling of the labor market."

A sharp and rapid increase in the unemployment rate typically only occurs during economic recessions, triggering the Sam rule last month, which signals an impending economic downturn. This is also why the recent sharp increase in the unemployment rate has garnered such widespread attention.

However, Claudia Sahm, the founder of the rule and chief economist at New Century Advisors, does not believe this is a signal of an economic recession, in part because the rise in the unemployment rate is due to many new entrants to the labor market still seeking suitable positions.

Nevertheless, Sahm stated that the slowdown in labor demand is still a cause for concern, as it means potential workers are being excluded even if it does not lead to an economic collapse. She noted that the current concern is the trend in the labor market, not necessarily an economic recession, and there are many reasons to believe we have not reached that point yet. However, she added:

"Even a slight softening in the labor market will have consequences."

In addition to the rise in the unemployment rate, other signs also indicate a slowdown in the job market. Job vacancies have been steadily decreasing since the surge in 2021 and 2022, approaching pre-pandemic levels. The unemployment rate is rising rapidly, especially among those who find it difficult to secure jobs or are more vulnerable to unemployment in a weak job market, including Black individuals and young people in their early 20s However, many economists believe that the job market is not collapsing, but returning to normal after experiencing strong labor demand. Many people see the recent slowdown as a benign adjustment.

Some signs indicate that the soft job report in July may be a one-time occurrence. For example, the number of people who lost their jobs due to temporary layoffs surged in July. When this happens, the situation usually reverses in the next set of data. For instance, in August 2010 and October 2013, although the number of temporary layoffs surged, it quickly subsided. However, it is worth noting that when the surge in temporary layoffs does not quickly subside, as in early 1980, the economy did indeed enter a recession.

Furthermore, the surge in layoffs in July may be related to severe weather. Although some analysts initially speculated that Hurricane "Beryl" may have prevented some people from working that month, the U.S. Bureau of Labor Statistics and economists at Goldman Sachs suggest that this may not be the main reason. Temporary layoffs mainly came from the Midwest and California, not the southern region ravaged by the hurricane. However, the hot weather may be part of the reason for this trend.

David Mericle, Chief U.S. Economist at Goldman Sachs, said, "Extreme heat in California appears to be related to some of the layoffs."

Even if July is not an isolated case, there are other signs that the job market remains robust. Mericle said, "The baseline scenario is that things will improve." He explained that labor demand is returning to normal, although not as strong as in 2022, but not completely frozen either. "This is more like the strength of 2019, rather than the strength of 2022."

Although initial claims for unemployment benefits have slightly increased, they remain at a low level. According to Goldman Sachs data, WARN notices used to signal large-scale layoffs have not increased significantly.

For the White House, even if the job market only slightly weakens, it could weaken the brightest part of the Biden administration's economic performance. But there are pros and cons: if the economic slowdown translates into the Fed speeding up rate cuts, lower borrowing costs could make voters feel better. Christopher Krueger, Managing Director of the TD Cowen Washington Research Group, said that voters are most concerned about the outlook for interest rates and the recent slowdown in price increases.

Krueger said, "Ultimately, voters are most concerned about the prices at the gas station, supermarket, and the cost of a happy meal."