US unemployment rises to 4.3% as Fed eyes rate cuts

Payroll employment climbed by 22,000 in August, which was roughly in line with the gains in other recent months.  The unemployment rate rose 0.1% to 4.3% after an increase of 0.1% in July.

That puts it just slightly above the 4.2% level that the Fed believes is the full employment threshold for the unemployment rate. For some time the Fed has been contemplating a couple of rate cuts late in the year but it has not yet pulled the trigger.

This employment report strengthens the case for those who were already leaning in that direction. The problem is that the core inflation rate has been steady at 2.9%. The Fed wants that inflation rate to slow to the 2.0% mark.

Tariffs are clearly putting upward pressure on prices for some goods which is making it difficult for the inflation rate to back down. While we believe that the Fed should postpone any rate cuts until the inflation rate  provides more convincing evidence that it is headed in the right direction, that is not going to happen.

The Fed will almost certainly cut the funds rate 0.25% at its meeting later this month with another 0.25% cut prior to yearend. It will justify that action by telling us that it is currently putting more weight on its full employment goal and that it is not particularly concerned about the stickiness of inflation which will, hopefully, prove to be temporary.

The labor market has clearly slowed in recent months. Payroll employment is currently increasing by about 30,000 per month versus monthly gains of 200,000 at the beginning of the year.  Business leaders are convinced that tariffs will slow the economy to some extent.

At the same time Trump is aggressively deporting illegal immigrant workers. That will shrink the labor force and further slow the economy. Against that background the economic outlook is unusually murky and firms are behaving cautiously. They are reducing headcount largely via attrition.

If someone leaves the firm they are not immediately filling the position. Firms also require executives to demonstrate that any new position cannot be accomplished satisfactorily via artificial intelligence. As a result, hiring has slowed dramatically.

Firms have not yet resorted to layoffs because they fear that they may not be able to rehire that worker when the economy rebounds.  Initial unemployment claims (a measure of layoffs) has only inched upwards.

While employment growth has slowed to a crawl the unemployment rate has only edged higher to 4.3% because the deportation of immigrant workers has shrunk the labor force.  The economy does not need to produce as many jobs today to keep the unemployment rate steady.

At the beginning of the year the labor force was increasing by about 150,000 per month.  To keep the unemployment rate steady employment needed to increase by 150,000 monthly.  But now the labor force is rising by only about 50,000 per month which means that employment gains of just 50,000 are required.

As a result of all this, the unemployment rate has edged upwards to 4.3%. The Fed believes that the labor market is at full employment when that rate is 4.2%. But Fed Chair Powell fears that with much slower growth in payroll employment any potential slowdown in GDP growth could result in a big increase in layoffs and a dramatic increase in the unemployment rate. He says that the balance of risks has changed and that the Fed intends to take action to ensure that the unemployment rate does not rise by cutting rates sooner rather than later.

The funds rate now seems almost certain to be cut by 0.5% between now and yearend. That would reduce it from 4.3% to 3.8%. The question is, then, what is likely to happen to it in 2026.  We believe that GDP growth in that year will be about 2.5%, the unemployment rate should return to 4.2%, and the inflation rate may slow from 2.8% to perhaps 2.2%.

That is getting very close to what the Fed would like to see — both full employment and 2.0% inflation.  Against that background the funds rate should continue to decline gradually to about 3.3% by the end of the year. The Fed thinks that over the long term the funds rate should be about 3.0%. While the economy is a bit shaky at the moment, slow but steady rate declines in the final months of this year and into 2026 should help.

From 1980 until 2003, when he retired, Stephen Slifer served as chief U.S. economist for Lehman Brothers in New York City, directing the firm’s U.S. economics group along with being responsible for forecasts and analysis of the U.S. economy. He has written two books on using economic indicators to forecast financial moves and previously served as a senior economist at the Board of Governors of the Federal Reserve in Washington, D.C. Slifer can be reached at www.numbernomics.com.