The labor market has remained surprisingly strong over the past year, but as job openings shrink and more people collect benefits, Federal Reserve officials are alert to cracks.
Central bankers have recently begun making it clear that if the labor market unexpectedly weakens, they can cut interest rates. This is a small change in their stance after years of working to cool the economy and rebalance an overheated labor market.
Policymakers have kept interest rates at 5.3 percent since July 2023, a decades-long peak that makes it more expensive to get a mortgage or carry a credit card balance. That policy setting is slowly squeezing demand across the economy, with the goal of bringing soaring inflation fully under control.
But as inflation cools, Fed officials have made clear they are trying to strike a careful balance: They want to make sure inflation is under control, but they don’t want to upend the labor market. Given that, policymakers have signaled over the past month that they would respond to a sudden weakening in the labor market by cutting borrowing costs.
The Fed would like to see more cooling inflation data “like we’ve seen recently” before cutting rates, Fed Chairman Jerome H. Powell said in a speech this week. “We also want the labor market to remain strong. We’ve said that if we see the labor market weaken unexpectedly, that’s something that could also prompt a response.”
Therefore, employment reports will likely be a key reference point for central bankers and Wall Street investors eager to see what the Fed will do next.
For years, the Fed has been monitoring the labor market for a different reason.
Officials worried that if labor market conditions remained tight for too long, with employers scrambling to hire workers and paying ever higher wages to attract workers, it could help keep inflation running faster than usual. That’s because companies with higher labor costs would likely charge more to protect profits, and workers earning more would likely spend more, fueling continued demand.
But recently, job openings have been falling and wage growth has slowed, suggesting the labor market is cooling from the boiling point. That has caught the Fed’s attention.
“Right now we have a good labor market, but not a frothy one,” Mary C. Daly, president of the Federal Reserve Bank of San Francisco, said in a recent speech. “A future slowdown in the labor market could lead to higher unemployment, as firms have to adjust not just job openings but actual jobs.”
The unemployment rate has risen slightly this year, and officials are watching with suspicion for a more pronounced movement. Research shows that a sudden and sharp rise in unemployment is a signal of a recession — a rule of thumb formulated by economist Claudia Sahm and often referred to as the “Sahm Rule.”