Non-farm payrolls grew by 73,000 in July and the unemployment rate increased by one-tenth to 4.2%. More importantly, job growth in the prior two months was revised down by a total of 258,000. Excluding the COVID period and its immediate aftermath, May to July represents the weakest three-month period of job growth since 2010. This sharp jobs’ slowdown has multiple causes including changes in immigration and tariffs policy, the uncertainty caused by the manner in which some of these policy changes have been rolled out, and the effects of growing use of artificial intelligence (AI) on the demand for certain types of workers.
The July employment report provides some insights into the effects of increased deportations on the labor market, but the picture remains incomplete. The report shows significant ongoing declines in the labor force participation rate of immigrants. For those immigrants responding to the household survey, the labor force participation rate has fallen from 67.3% a year ago to 66.1% in July.
The household survey does not capture the extent to which the willingness of immigrant households to participate in the survey has changed and the near-term fluctuations in the number of such households in the country. But the ones the survey is reaching are reporting significantly lower labor force participation.
Meanwhile, the unemployment rate among-native born workers has been rising. It currently stands at 4.7% (up from 4.5% last July) and is at its highest rate in eight years (excluding the COVID period and its immediate aftermath).
Tariffs Aside, AI Is Eating into White-collar Jobs
While the overall unemployment rate has shown little change in the past year, there have been some indications that younger, college-educated workers have been disproportionately affected by the adoption of AI-related technologies. In recent decades technological change has been biased against workers with a high school education or less and has enhanced the earnings of college-educated workers. There are early indications that the pattern with AI could be somewhat different and that it will reduce demand for certain kinds of white-collar workers.
Two days before the July employment data were released, the Federal Open Market Committee (FOMC) met and kept policy unchanged. It is fair to say that the committee would have made a different decision with the July employment report in hand.
With the weak job growth of the past three months, the question for the FOMC at the next meeting will be whether to cut interest rates by 25 basis points or 50. There will be one more employment report between now and September 16-17. The results of that report will determine the size of the easing of monetary policy. At this point, it is more likely than not that the committee will opt for a 50 basis point easing. The cracks in the labor market have simply widened by much more than the previously released data had suggested.
Moreover, the data on wage inflation point to a lack of inflationary pressures coming from the labor market. Two of the main measures of wage inflation (the Employment Cost Index and average hourly earnings of production and nonsupervisory workers) show wage inflation rising at the same rate in the first half of 2025 as in 2024. Aside from the potential effects from tariffs, the outlook for consumer prices is benign. Not only is there a lack of upward inflationary pressure from the labor market, conditions in the housing sector are also in place for additional deceleration in rental inflation.
Higher Unemployment Could Lead to Aggressive Cuts in Interest Rates
Tariffs policy, of course, remains highly problematic. The first half of 2025 was dominated by wild swings in tariffs policy, which in turn generated unprecedented quarterly gyrations in imports—up 38% in the first quarter as firms rushed to beat the tariffs and down 30% in the second. GDP growth was slightly negative in the first quarter but rebounded to 3% in the second. That still made for a weak overall first half, a conclusion reinforced by the data on jobs growth.
The erratic manner of the rollout in tariffs policy may have limited the extent to which firms have passed on price increases to consumers. Hopes that the tariffs would be short-lived might have persuaded some firms to take a short-term hit to their bottom lines rather than risk losing customers or market share. However, in late July and early August new and relatively high tariffs were being announced against Canada, India, and other countries. If this policy yo-yo drags out further, more firms will decide to bite the bullet and increase prices.
However, for the Federal Reserve the main focus now has to be on the vulnerability of the economy and labor markets. The weakness in the July employment report implies more aggressive interest rate cuts are likely in the remaining months of 2025 than had previously been the case.
