Fed's Wait-and-See Stance Holds as July Payrolls Drop 23,000

The Federal Reserve can remain in "wait and see" mode after July payrolls fell 23,000, with September hike odds dropping below 50 percent and the next inflation reading becoming the swing factor for policy.

"We think the Fed can stay in wait and see mode and see how economic data evolves," Collin Martin, fixed income strategist at Charles Schwab, said. "Last week's decline in jobs through the July jobs report is changing the calculus."

Payrolls fell 23,000 in July against forecasts of an 80,000 increase, with May and June revised lower by a combined 103,000. The unemployment rate dipped to 4.1 percent from 4.2 percent in June as labor force participation declined 0.7 percentage points since January. Wage growth held at 3.2 percent year over year, keeping the inflation impulse from the labor market contained.

With the fed funds rate at 3.50-3.75 percent and September hike odds below 50 percent, Wednesday's consumer price index report will determine whether the Fed's hold extends through the fall or a hike returns to the table. A meaningful upside surprise in price data would be required for the Fed to raise rates as soon as September, according to Thomas Ryan, senior economist at Capital Economics.

Job losses in July were concentrated in local government education, which declined by 50,000, retail, which cut nearly 20,000 positions, and the financial sector, which shed 14,000 jobs. Healthcare added 22,000 jobs. The weakness has not yet appeared across the broader set of labor market indicators, Ryan said, but it is likely to rekindle concerns among Fed officials about the labor market's health and make them less willing to commit to near-term tightening.

The softer jobs data rippled across asset classes. The 10-year Treasury yield, the Dollar Index, and oil prices all moved lower, while gold surged more than 7 percent and global equities rebounded sharply. The market-implied probability of another Fed hike fell, shifting risk from terminal-rate fear toward data dependency and curve relief.

Fed Governor Lisa Cook, who supported holding rates steady at the Fed's July meeting, said she is ready to act if inflation does not show signs of easing soon, while weighing how rate increases might affect labor market stability. She said she would back a hike if needed to bring inflation down, but that may not be necessary as some disinflationary forces are already at work.

The debate echoes the start of the year, when job growth was similarly uneven and some Fed officials argued that zero job growth could still indicate a balanced labor market. San Francisco Fed President Mary Daly said then that policy changes reducing immigration, which pushed workforce growth toward zero, meant traditional benchmarks for labor market health were shifting. Fed Governor Chris Waller also said early this year that zero job growth could still be consistent with a balanced labor market if the unemployment rate remained stable.

The next CPI print is now the real swing factor, not employment strength. If inflation comes in hotter than expected, policymakers have said they are prepared to act. If it cools, the Fed's hold could extend through the fall, with the labor market's resilience becoming the dominant concern for a committee that has kept rates unchanged since July.

This article is for informational purposes only and does not constitute investment advice.