Back in June, we discussed the weakening trend in U.S. employment growth, as observed from the consistent downward revisions to the monthly employment reports through May[1]. The July revisions not only continued this trend but also accelerated it meaningfully (see Exhibit 1). In fact, the revisions accompanying the July Employment Situation report from the U.S. Department of Labor were the largest in decades outside of recessionary periods (assuming we are not currently in one). Year-to-date downward revisions are approaching 500,000, nearly half of the initially reported figures.
While the Trump administration blamed the messengers for these weak reports and ultimately dismissed the head messenger, BLS Commissioner Dr. Erika McEntarfer, downward adjustments, especially at turning points in the economic cycle or during downturns (i.e., recessions), are quite normal. There is no question that labor markets are on shaky ground, and further weakening in the coming months is likely as businesses grapple with continued policy uncertainty from Washington.
Policy uncertainty emanating from Washington also had an impact on the July inflation report. While the full impact of tariff policies on inflation will take many more months to assess, their effects are beginning to filter through month-by-month.
Although headline inflation continues to moderate, some pass-through effects from tariffs are starting to appear beneath the surface. As shown in Exhibit 2, headline inflation over the past two years has been dominated by the services sector, which constitutes roughly 60% of the overall Consumer Price Index (CPI). However, over the past several months (beginning in May to be precise), this contribution has been declining. In fact, the contribution of services to consumer inflation (roughly 87% over the past 12 months) is now at its lowest level since May 2023. Goods, including food and energy, which make up the remaining 40% of consumer prices, have begun to play a larger role in driving overall inflation. This is precisely where the impact of tariff policy is most directly observed.
Taken together, neither of these trends provides the Federal Reserve with comfort in its current monetary policy stance. However, we believe that weakening employment trends, likely to continue if not accelerate in the months ahead, have now become the bigger concern for the central bank. This could be the catalyst needed for the Fed to finally resume reducing interest rates at its mid-September Open Market Committee meeting.
As always, stay tuned.
Ardavan Mobasheri
Chief Economist
