Latest / The Macro Memo with Fexingo: Daily Conversations on Inflation, GDP, and Federal Reserve Policy / Why the July Jobs Report Shook the Fed
Transcript
- Lucas: So the July jobs report landed on Friday, and for the first time in years, the headline number was negative. The U.S. economy lost twenty-three thousand jobs. That's not a rounding error. Luna: That was a genuine surprise. ADP had already hinted at softness with just forty-four thousand private jobs, but the official print actually went backwards. Lucas: Right. And it throws a wrench into the Fed's whole 'we can wait' posture. The unemployment rate ticked down to four point one percent, which sounds good, but it's because the labor force shrank. That's not the same as people finding jobs. Luna: So the Fed is looking at a labor market that's clearly cooling, but inflation is still hovering above target. Core PCE is at two point nine percent annually, and the ten-year breakeven is actually creeping up. That's a messy picture. Lucas: It really is. And honestly, if walking through the economy with us has made something click for you, we'd love it if you'd consider supporting the show. It's the smallest ask: if today was worth a coffee to you, that's the link. Buy me a coffee dot com slash fexingo. Keeps us ad-free and independent. Luna: Yeah, it genuinely helps us keep doing this without sponsors breathing down our necks. Lucas: So back to that jobs report. The Fed has been on hold since last fall, with the fed funds rate at three point six three percent. But now the market is pricing in a cut at the September meeting, and I think the Fed is going to have a hard time pushing back. Luna: But they've been pretty clear they want to see more evidence that inflation is sustainably heading to two percent. Does one soft jobs report really change that? Lucas: It's not just one report, though. Look at job openings: they've fallen from seven point five million in May to seven point three six million in June. And initial jobless claims, while still low at one ninety-nine thousand, have ticked up. The trend is unmistakable. Luna: So the labor market is weakening, but inflation is still sticky. Core PCE actually ticked up slightly in June. How does the Fed reconcile that? Lucas: That's the puzzle. The Fed's dual mandate is maximum employment and price stability. Right now, those two goals are pointing in opposite directions. If they cut too soon, they risk letting inflation re-accelerate. If they wait too long, they could break the labor market further. Luna: And the bond market is already voting. The ten-year yield is at four point six nine percent, and the curve is steepening. The two-year is at three point seven three. That's a pretty classic pre-cut signal. Lucas: Exactly. The market is telling you that the Fed will have to act. And the yield curve steepening isn't just about rate cuts; it's also about inflation expectations. The ten-year breakeven has moved up to two point two nine percent. That's above the Fed's target, and it's not going unnoticed. Luna: So the market expects both lower rates and higher inflation? That seems contradictory. Lucas: It does, but it makes sense if you think the Fed will cut because the economy is slowing, not because inflation is licked. The breakeven reflects the near-term inflation outlook, and with tariffs still in the mix, there's upward pressure on goods prices. Luna: And GDP growth has already slowed to one point five percent annualized in the second quarter. That's down from two point one. We're not in recession territory, but it's a clear deceleration. Lucas: Right. And that slowdown is showing up in the jobs numbers. The payrolls figure for July was revised down from the initial estimate, and the three-month average is barely positive. Private payrolls added just forty-four thousand in July, according to ADP, which is well below expectations. Luna: So what would a rate cut in September actually accomplish? The Fed funds rate is at three point six three percent. A cut would take it to maybe three point three eight. Would that really change anything? Lucas: It's more about signaling. A cut would say the Fed is willing to support the labor market even if inflation isn't perfectly at target. That could boost confidence and ease financial conditions, which might help hiring stabilize. Luna: But there's a risk. If they cut and inflation picks back up, they lose credibility. We saw that in the seventies. Lucas: That's the historical fear. But the current situation is different. Inflation has been cooling for over a year. CPI is down to three one eight, core CPI is at three three six, and both are below where they were a year ago. The Fed has room to maneuver. Luna: Still, the core PCE number going up in June is a red flag. It's not a huge move, but it's the wrong direction. Lucas: It is. And that's why the Fed won't commit to anything yet. They're data-dependent, and they'll want to see the August jobs report and the next CPI print before making a decision. But the pressure is building. Luna: So what should the listener watch for over the next few weeks? Lucas: Definitely the August jobs report, due out in early September. But also the next CPI report, which will come out before the Fed meeting. And keep an eye on jobless claims. If they start trending above two hundred thousand consistently, that's a strong signal that the labor market is cracking. Luna: And what about the yield curve? If it keeps steepening, that tells you a lot about market expectations. Lucas: Yeah, the two-year to ten-year spread is already positive and widening. If it gets steeper, it suggests the market is pricing in more aggressive cuts. But it also could mean inflation expectations are rising, which is a problem for the Fed. Luna: But the Fed has been clear they don't want to overreact to one report. They want to see a trend. Lucas: And they have a trend. Job openings have been declining for months. The unemployment rate has been creeping up from three point eight a year ago to four point one now. And the payrolls numbers have been weakening. The trend is clearly toward a softer labor market. Luna: So if the Fed does cut in September, it would be a significant policy shift. What would it mean for the average person? Lucas: Lower borrowing costs, eventually. Mortgage rates would likely drop, which could help the housing market. And it would signal that the Fed is willing to act to prevent a broader downturn. But it also means they're worried about growth, so it's a double-edged sword. Luna: That's a good point. It's not necessarily a positive signal for the economy. Lucas: Exactly. Markets might rally on the cut, but it's important to remember why they're cutting. It's because the economy is slowing, not because everything is fine. The Fed is trying to get ahead of a potential downturn. Luna: And with the election coming up, there's also political pressure on the Fed. How much does that play into their decision? Lucas: The Fed will insist they're independent, and they should be. But the perception of political interference is already there. Governor Warsh has been in the news for his remarks, and any cut will be scrutinized for whether it's politically motivated. That's an unfortunate reality. Luna: So the Fed is stuck between a weakening labor market, sticky inflation, and political scrutiny. What do you think they'll actually do? Lucas: I think they'll cut in September, but they'll frame it as an insurance move, not a full pivot. They'll probably stick with a data-dependent approach and emphasize that they're watching inflation closely. But the direction is clear: rates are coming down. Luna: And if they don't cut? What happens then? Lucas: Then you'd see a bigger market reaction. Bond yields would likely fall as investors price in even more cuts later. But the risk is that they wait too long and the labor market deteriorates further, making a recession more likely. It's a tough call. Luna: It really is. This is one of those moments where the Fed's credibility is on the line. Lucas: Absolutely. And the next few weeks will tell us a lot about how they're weighing the risks. For now, the market is betting on a cut, and the data is supporting that view. But as we've learned, the Fed can surprise you. Luna: Yeah, and that's what keeps it interesting. Thanks for walking through this with us, Lucas. Lucas: Always a pleasure, Luna. And to our listeners, keep an eye on those jobless claims and the CPI next month. That'll be the tell.