U.S. July Non-Farm Payrolls Analysis: Job Growth Slows, Rising Unemployment Triggers Recession Indicator

Data Interpretation

Summary:

The seasonally adjusted U.S. non-farm payrolls increased by 114,000 in July, with figures for the previous two months revised downward. The unemployment rate unexpectedly rose for the fourth consecutive month to 4.3%, indicating a faster-than-expected cooling of the labor market. This raises concerns about a worsening job market and the potential for an economic recession.

The non-farm payroll report released by the U.S. Bureau of Labor Statistics last Friday showed that non-farm payrolls grew by just 114,000 in July, significantly lower than the market expectation of 175,000 and the previous reading of 179,000. The average monthly increase over the past three months was 167,000. Additionally, the non-farm payrolls for May and June were revised downward by 2,000 and 29,000, respectively, to 216,000 and 179,000.

The report reveals a broad-based cooling in the non-farm payrolls and poor structural quality:

Government payrolls rose by 17,000 in July, down from a 43,000 increase in June, with state and local government jobs showing a marked decline. Private sector jobs increased by 97,000, down from the previous month's 136,000.

Private services jobs rose by just 72,000, below a 125,000 increase in June, with information, financial activities, and temporary services being the main drags. Education and healthcare added 57,000 jobs, contributing approximately 50% of the total job growth.

Goods-producing sectors added 25,000 jobs in July, higher than June's 11,000. Construction employment continued to rise, with 25,000 new jobs created, higher than the previous month's 20,000. Manufacturing jobs rose by 1,000. U.S. July Non-Farm Payrolls Analysis: Job Growth Slows, Rising Unemployment Triggers Recession Indicator_1

U.S. July Non-Farm Payrolls Analysis: Job Growth Slows, Rising Unemployment Triggers Recession Indicator_1

U.S. July Non-Farm Payrolls Analysis: Job Growth Slows, Rising Unemployment Triggers Recession Indicator_2

Moreover, accommodation and food services added 25,600 jobs, with 19,500 in food services and 6,100 in accommodation sector. This suggests a small employment rebound in the leisure and hospitality sector as the summer travel season began.

Despite resilient spending on accommodation and food services in the second quarter, which grew by 6% from a year ago, above the pre-pandemic trend level of 5.8%, the latest JOLTS report shows continued weakening in leisure and hospitality hiring. June job vacancies fell from 1.068 million to 900,000, indicating potential low-level fluctuations in subsequent job growth.

The rebound in goods-producing job growth was mainly driven by the construction sector, reflecting growing non-residential interior design demand. Construction employment, often a leading indicator of economic changes, rose by 25,000 in July, slightly above the average monthly gain of about 20,000 jobs over five years before the pandemic. This could signal a recovery in the housing starts, which have been subdued for months.

Manufacturing jobs grew by 1,000, compared with a previous decline of 9,000, though the ISM Manufacturing PMI dropped from 49.3 to 43.4, indicating ongoing weakness in manufacturing.

Private sector job gains decreased significantly to 97,000 in July from 136,000 in the previous month. Healthcare was the main contributor to the job gains and construction employment continued to rise. However, information, financial activities, and temporary services saw notable declines of 20,000, 4,000, and 9,000 jobs, respectively. U.S. July Non-Farm Payrolls Analysis: Job Growth Slows, Rising Unemployment Triggers Recession Indicator_3

U.S. July Non-Farm Payrolls Analysis: Job Growth Slows, Rising Unemployment Triggers Recession Indicator_3

Notably, government employment increase saw a significant drop to 17,000, down from 43,000, with state and local government jobs increasing by only 16,000, down largely from a rise of 41,000 in June. This decline is one of the main reasons for the overall drop in July non-farm payrolls. The slowdown in government employment growth could be anticipated from the JOLTS data released last Tuesday, which showed a large increase in state and local government job vacancies (+118,000), especially in education (+24,000 job vacancies). Meanwhile, both hiring and quitting fell, reflecting a decline in employment.

Furthermore, according to forecasts from the National Association of State Budget Officers, state and local government spending in fiscal year 2025 is expected to drop significantly from the 2024 level. Additionally, state and local governments' Education Stabilization Funds are nearing depletion (with states having spent 80%-95% of the awarded funds), suggesting future downward pressure on state and local government education job gains.

Given that state and local government education has been a major influence on government employment performance, reduced education spending could lead to a reduction in state and local government education jobs, impacting overall job growth. The cooling trend in state and local government job creation is expected to be somewhat sustainable in the future.

The unemployment rate rose by 0.2 percentage points to 4.3% in July from the previous month, the highest level since October 2021, exceeding the expected 4.1%. The increase in unemployment nearly triggers the "Sahm Rule" recession indicator. According to the Sahm Rule, if the unemployment rate (based on a three-month moving average) rises by 0.5 percentage points from its low of the previous year, a recession has begun, and this indicator has a 100% accuracy rate since 1970.

However, the data suggests that the recent rise in the unemployment rate may primarily be attributed to an increase in the labor force population coupled with a decline in hiring demand.

Since the onset of the pandemic, a significant influx of immigrants into the U.S. has led to an increase of approximately 4.1 million in the overall labor force. Moreover, the growing acceptance of remote work has resulted in an increase of 1.85 million in the number of working-age individuals with disabilities compared to pre-pandemic levels, a segment of the population that generally faces more substantial employment challenges. The confluence of these factors, along with a decrease in recruitment needs, is likely contributing to the rapid increase in the unemployment rate. Supporting this observation are the recent declines in job openings reported by JOLTS for the private sector, as well as rises in both initial and continuing jobless claims.

Sahm herself expects that the U.S. economy is unlikely to enter a recession, as it did not follow the conventional patterns of economic downturns and recoveries during the pandemic. Additionally, the increase in immigration post-pandemic could distort the effectiveness of labor market indicators.

From the perspective of unemployment distribution, the number of temporary layoffs surged by 249,000 to a total of 1.062 million following Hurricane Beryl, marking the highest point since September 2021, while the average monthly level over the past year has been slightly over 800,000. If the subsequent temporary unemployed individuals return to work, the unemployment rate may improve. Analysts project the unemployment rate to decrease to approximately 4.1% in August.

Despite the disappointing overall employment data in July, the employment rate among prime-age workers remains robust. In terms of the labor force participation rate, as of July, the U.S. labor force participation rate stood at 62.7%, still 0.6 percentage points below that of February 2020. Notably, the participation rate for the prime working-age population is 84.0%, which is 1.0 percentage point higher than in February 2020.

Last Friday, following the release of the non-farm payrolls, U.S. stocks, the U.S. Dollar Index (USDX), and Treasury yields experienced significant declines. Gold initially rose before subsequently falling, as expectations for interest rate cuts intensified, exacerbating concerns about an economic downturn. The S&P 500 dropped by 1.8%, with the yield on the 10-year Treasury securities decreasing by 18.2 basis points to 3.80%. The USDX closed at 103.2, a decline of 1.1%. This situation not only reflects investor apprehension regarding an economic slowdown but also indicates a shift in market expectations concerning Fed policy. Until further data confirms that the U.S. economy is not heading towards recession, it is highly probable that the stock market will continue to trade on recession fears.

The closely monitored inflation gauge - average monthly earnings only increased by 0.2%, falling short of the expected 0.3%, while the year-over-year increase in average hourly wages dropped to 3.6%, marking the smallest annual growth since May 2021, compared to a rise of 3.8% in June. The primary reason for this is the ongoing closure of the employment supply-demand gap, which is leading to a gradual easing in wage growth. Since 2024, the average monthly labor supply-demand gap has been 1.88 million, significantly shrinking from an average of 3.35 million in 2023. Currently, there are 1.2 job openings for every unemployed person, effectively equal to the pre-pandemic level of 1.19, indicating a more balanced labor market supply and demand situation.

Overall, the U.S. labor market continues to weaken, with a persistent slowdown in wage growth and a rising unemployment rate. Additionally, the economic indicators reflecting the U.S. economy are also witnessing a continual decline; in July, the manufacturing PMI fell to 46.8, while the services PMI remained below 50 in June. The University of Michigan's Consumer Sentiment Index dropped to 66.4 in July, and the ADP employment figures recorded the lowest number since February. These data points have intensified concerns in the market regarding the future of the U.S. economy, significantly increasing expectations for interest rate cuts.

After the release of the July non-farm payrolls, U.S. President Biden issued a statement acknowledging the slowdown in job growth, framing it within the context of the economy returning to normalcy. He noted that the non-farm payrolls indicate a deceleration in employment growth amid a significant decrease in inflation.

The non-farm payrolls lay the groundwork for a potential interest rate cut by the Fed in September. The market not only expects that a rate cut in September is a certainty but has also increased its bets on substantial reductions in rates. According to the CME FedWatch Tool, the market expects a 30.5% probability that the Fed will cut rates by 25 basis points in September, with a 69.5% probability of a 50 basis point cut. Furthermore, there is an expectation of three rate cuts within the year, totaling a reduction of 125 basis points.

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U.S. July Non-Farm Payrolls Analysis: Job Growth Slows, Rising Unemployment Triggers Recession Indicator

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