By Nick Timiraos and Paul Kiernan
The script is being flipped for the U.S. economy.
For 2 1/2 years, high inflation has drawn a nearly single-minded focus from the Federal Reserve and the White House as the nation's foremost economic challenge.
But in the span of a week, punctuated by a surprisingly lackluster July hiring report on Friday that sent markets reeling, the labor market has become the locus of concern for economic policymakers in Washington.
Fed officials have spent the year trained on ensuring inflation moves down without causing unnecessary weakness, achieving a so-called soft landing. Given recent declines in inflation, "Now the question is whether we are settling at full employment, or whether we are blowing through full employment. That's a critical question," said Chicago Fed President Austan Goolsbee in an interview Friday.
A broader economic slowdown, if it materializes in coming months, could also upend an already volatile presidential race between former President Donald Trump and Vice President Kamala Harris.
"It goes without saying that if the economy rolls over, the odds of Harris becoming president would dwindle," said Marc Sumerlin, an economist who advised President George W. Bush.
Whether the latest data reflect an economic soft patch or a more ominous downturn could depend on how the Fed responds in the months ahead and whether lower interest rates shore up a slowing economy.
Fed Chair Jerome Powell this past week signaled a rate cut was likely at officials' meeting next month. They voted Wednesday to hold their benchmark short-term rate steady at the highest level in two decades.
Inflation has fallen from a high of 7.1% two years ago to 2.5% in June, according to the Fed's preferred gauge. The unemployment rate rose to 4.3% in July, up from 4.1% in June and 3.7% at the beginning of the year.
"Inflation is no longer the issue," said Laurence Meyer, a former Fed governor, in an interview Friday. "The situation has just totally changed."
Fed Chair Jerome Powell signaled Wednesday at a news conference that a rate cut was likely in September. Photo: Kevin Mohatt/Reuters
Investors are afraid the Fed is running late. Friday's report shifts the debate from when officials will cut to how large their reduction next month should be: a traditional quarter-point cut or the larger half-point reduction, such as what occurred on the eve of recessions in 2001 and 2007.
'They look offsides'
Many analysts expect the Fed will cut rates by a quarter-point at each of its three remaining meetings this year. That would lower the Fed's rate to just above 4.5%, from its current 5.3%.
A handful of economists said Friday that the Fed will need to move faster to improve its odds of short-circuiting a downturn. That is because interest rates were raised last year to a level that aims to slow economic growth, as a driver presses down on the brake of a car.
If the economy is now slowing down more than the Fed anticipated, the central bank will need to set rates closer to a so-called neutral level, effectively taking its foot off the brake. While the neutral rate can't be observed, many economists think it might be between 3% and 4%.
Some weakness in the jobs report might have been exaggerated, said Michael Feroli, chief U.S. economist at JPMorgan. The higher unemployment rate reflected a big jump in people who faced a temporary, as opposed to permanent, layoff. While hiring has slowed this year, the unemployment rate has crept up in large part because more people who weren't previously looking for jobs have sought work.
Because Feroli thinks rates need to be closer to neutral relatively soon, he expects the Fed to cut rates by 1.25 percentage points this year, including by a half-point at each of its next two meetings in September and November.
The campaign of former President Donald Trump seized on Friday’s jobs report as evidence of a looming recession. Photo: Spencer Platt/Getty Images
"They look offsides," Feroli said. "There is good reason to get back onsides here. I don't see the rationale for going slow, even if the data don't disappoint in a big way over the next six weeks."
An underwater beach ball
Already, a bond-market rally has lowered borrowing costs in anticipation of Fed cuts. (Bond yields fall when prices rise.) That is good news for would-be home buyers. The average 30-year mortgage rate tumbled to 6.4% on Friday, down from 6.86% a week earlier, according to Mortgage News Daily. Any boost in demand for housing might boost spending that cushions softness elsewhere in the economy.
A sustained stock-market downturn, however, could be perilous. The postpandemic expansion has been fueled to an unusual degree by strong growth in incomes and asset prices, such as lofty stocks -- as opposed to a more traditional boom in lending and credit growth.
Because a strong labor market and buoyant stock market have been critical growth engines, if both lose steam, the economy could sputter.
A related concern is that job-market weakness might be masked because companies that labored mightily to rehire workers after the pandemic are reluctant to let them go. A rapid shift in sentiment -- triggered, for example, by a significant stock-market rout -- could serve as a catalyst for firing workers and slashing investment plans.
Like a beach ball that shoots up after being held underwater, once sentiment flips and companies decide demand is too soft to keep those workers, joblessness would climb much faster than it has so far.
Facing somewhat weaker domestic growth, the European Central Bank and the Bank of Canada began cutting rates in June. The Bank of England joined them this past week.
Election effects
Negative economic headlines, a pickup in layoffs and continued stock-market turmoil would seriously set back Harris's campaign to keep Democratic control of the White House. Voters tend to punish incumbent presidents -- or their party -- when economic sentiment is heading south.
While an unemployment rate anywhere below 5% is historically low, the recent trend could matter more than the overall level. President Barack Obama was re-elected in 2012 with an unemployment rate that had edged just below 8% -- but had fallen from a high of 10% three years earlier.
A pickup in layoffs would pose a setback to Vice President Kamala Harris’s campaign. Photo: Edward m. Pio Roda/EPA/Shutterstock
And Democrats failed to maintain control of the White House in 2000 and 2016 despite an unemployment rate that had fallen to its lowest level in years.
The Trump campaign had already made the Biden administration's stewardship of a high-inflation economy a centerpiece of its bid for the White House. Higher unemployment would allow Republicans to launch a double-barreled attack.
Trump's campaign seized on Friday's data as evidence of "a looming recession," calling it "a five-alarm-fire jobs report."
Still, the current labor market can't reasonably be described as weak. Unfilled jobs outnumber unemployed workers, and layoffs have remained subdued. President Biden, in a statement after the jobs report, noted that nearly 16 million jobs had been created since he and Harris took office. The Harris campaign declined to comment further.