The U.S. Labor Market Is Gradually Cooling

Unusually, the revisions to previous months were trivial overall, with a net loss of 8,000 jobs in May and June. But the revisions were very negative for government jobs (down 41,000), while positive in the private sector (up 33,000).

In the details, July showed continuing job losses in manufacturing (down 2,000), with no big moves across the industries. Construction payrolls lost 12,000 jobs, more in line with expectations after June's 3,000 increase. The biggest decline was in the nonresidential segment, rather than residential construction—surprising because nonresidential building activity is booming, while residential activity is slumping. Interpretation of these details is difficult, though, because the classification of construction firms in the employment report does not always correspond with the type of work that they are now doing.

Services-producing employment rose 104,000 in July, down from a 133,000 gain in June. But this slowdown was entirely caused by the drop in government employment. Private services job growth actually accelerated, hitting 132,000 this month, after totaling 114,000 in June. Leisure and hospitality services continue to do well, adding 22,000 jobs, including another strong increase in food services and drinking places (up 22,000). Retail jobs were little changed (down 1,000).

As usual, healthcare payrolls had a solid increase (up 36,000), while business services employment was also positive overall, up 26,000. But the business service details gave mixed signals. Professional and technical services employment rose 26,000, led by a 15,000 gain in computer systems design. But employment services demand fell 21,000 (with temporary help down 7,000), continuing a recent pattern of decline. The message seems to be that skills are still in demand, but that companies have become more cautious about the outlook, and as a result are cutting back their use of outside help.

The financial sector was a support to job growth in July, adding 21,000 jobs in finance and insurance (11,000 of those in credit intermediation) and 7,000 jobs in real estate and rental. Given the recent spate of bad news in the mortgage sector, these gains do not look sustainable. Only yesterday, American Home Mortgage Investment announced that it is laying off more than 6,000 workers.

The government sector has been a major contributor to employment growth over the past year, but that changed dramatically in July, when the sector shed 28,000 jobs. This is the first decline in government payrolls since January 2006. Education took the biggest hit (down 18,000). The drop may be due to seasonal adjustment quirks, since it is very difficult to adjust for the end of the school year. But downward revisions to May and June suggest that there may be more than simply seasonal issues at play. Government job creation was also revised down sharply for May and June, losing a total of 41,000 jobs, with 29,000 of those in education. This implies that the underlying trend in education job growth is not as strong as it had seemed.

The unemployment rate rose from 4.5% to 4.6%, at the high end of the narrow 4.4–4.6% band where it has fluctuated since last September. The rate came within a whisker of hitting 4.7% this month, since the unrounded number was 4.647%. Household employment fell by 3,000, while the labor force rose by 159,000. We expect the unemployment rate to continue to edge higher—the surprise has been that it has remained so low for so long, given the economy's slowdown.

Average hourly earnings growth was 0.3%, down from an upwardly revised 0.4% in June. The year-over-year growth rate held steady at 3.9%. Wage inflation is a risk for the Federal Reserve, but is presently in a zone that is providing support to consumer income growth, without running so high as to pose a major threat to price inflation, and it does not seem to be accelerating.

Total hours worked fell 0.1% in July, after a 0.5% increase in June, suggesting that hours in the third quarter will grow more slowly than the 2.3% increase in the second. This is consistent with the notion that the second quarter's 3.4% real GDP growth rate overstated the economy's underlying momentum, and that 2.0–2.5% growth is more likely in the second half of the year.

The bottom line is that the labor market is gradually cooling off, in line with the economic slowdown. And with GDP growth in the 2.0–2.5% range over the second half of the year—weighed down by the housing market retreat, plus cautious spending by consumers and businesses—the labor market will likely cool further. But both employment and real wages should keep climbing, providing some support to consumers in the face of high gasoline prices and falling home prices. We do not yet foresee the sort of job market breakdown that would prompt the Fed to step in and cut interest rates.