U.S. unemployment rises as the Fed holds tight on key interest rates

The unemployment rate climbed to 4.3% in July, up 0.2% from June, the Friday employment report from the Bureau of Labor Statistics shows, alarming some economists who believe the Federal Reserve has waited too long to cut interest rates.

The economy added 114,000 jobs and the number of people who were on temporary layoff rose by 249,000. The economy continued to add jobs in health care, social assistance and construction. According to the Bureau of Labor Statistics, the addition of government jobs slowed down in the past few months and was little changed in July, with the sector's jobs increasing by 17,000 jobs.

"We've seen for several months a bit of softening in the labor market even though it is quite strong by historical standards …," said Elise Gould, senior economist at the Economic Policy Institute, a left-of-center economic think tank. "There's been no inflationary pressures coming from the labor market as wage growth continues to decelerate."

Gould added that she thinks the Fed has waited too long to cut interest rates given what the labor market data shows.

"The softening is a little bit more concerning and we might be getting there sooner, that sort of cooling, than is necessary," she said.

The Fed decided not to cut rates during its most recent meeting, it announced on Wednesday. Fed Chair Jerome Powell said the central bank still needs to see more data showing that inflation is dropping enough to justify cutting rates. Despite recent upticks in the unemployment rate, Powell said the labor market was normalizing from a hotter job market. But he indicated that it is possible the Fed will be ready to cut rates by September.

"We've seen one quarter of good inflation and we've seen the labor market move quite a bit. As I mentioned, I don't think it needs to cool off any more for us to get the inflation results that are related to the labor market … That time could be in September if the data supported that," he said.

Powell added that he did not see evidence in the economic data that the economy is "sharply weakening."

The Fed began raising interest rates in March of 2022 to combat inflation but stopped raising rates in the fall of last year. The Fed said it was still attentive to getting inflation back down to its target of 2% but also needed to meet its dual mandate, which includes maximum employment. The Fed has used higher interest rates as a tool to cool the economy when it has seen it as heating too quickly, but it is often a controversial one because of the risks it presents to the labor market. In June, the inflation measure most valued by the Fed, the personal consumption expenditures price index, rose 0.1% and increased 2.5% over the past 12 months.

Although economists say that the economy is in a healthy place, that can change quickly, and many have advised the Fed to stay cautious to that risk by cutting rates quickly and deeply. Although inflation has squeezed families, high interest rates have also affected the housing market, where homeownership remains out of reach for many and rent has climbed as a result of greater demand in the rental market. Higher interest rates have also been a source of frustration for families because it has increased the cost of borrowing money, economists told States Newsroom.

"The consequence of having an extremely high interest rate for a really, really long time is that the labor market starts to crack. That's what high interest rates are designed to do," said Dr. Rakeen Mabud, chief economist at the Groundwork Collaborative, a progressive think tank. "It's always anyone's guess about exactly when that crack will open up into a giant chasm, and I hope we don't get to that point. But I think the longer that the Fed keeps rates high, the more they're playing chicken with people's lives."

Mabud added that she does not see how the root causes of inflation will be addressed by the Fed keeping rates where they are, since she attributes them to factors outside of the Fed's control, including supply chain issues, a shift in demand because of the pandemic, and companies that used "their market power and inflation to jack up prices."

Economists have been paying close attention to the unemployment rate because the Sahm rule, a measure to figure out whether the country is entering a recession, was triggered by the current unemployment rate. The Sahm rule is when the unemployment rate moves up by certain percentage points compared to previous employment data. July's unemployment rate has entered into the territory that economists say "triggers" the rule. Still, there may be reason not to panic just yet.

Gould said that in the case of this report, it's key to understand that the unemployment rate can rise because people who were not counted as part of the labor force, because they were not actively looking for work, are coming back into it and being included in the group of people who are unemployed.

"People are feeling optimistic about their job opportunities. They're coming back in or they're entering the labor force for the first time trying to find jobs, and many of them did not find jobs in July, but they are feeling good about it," Gould said.

Jesse Rothstein, professor of public policy and economics at the University of California, Berkeley, said it may be time for the Fed to adjust its policy and put the foot back on the gas of the economy.

"This is a kind of softening that we haven't really seen before," he said. "It's not quite as quick as it's been when we go into recessions, despite triggering the Sahm rule. We've been aiming for a soft landing and I think the Fed has been doing an extremely good job of that so far, but a soft landing requires frequent kinds of small adjustments."

The labor market has shown encouraging signs for the fight to slow inflation. Wages have increased by 3.6% from a year ago. Gould said 3.6% is the lowest gain economists have seen in two years, which shows that there are not inflationary pressures in wages for the Fed to worry about in this report. The news for workers isn't all bad either.

"You can applaud nominal wage growth decelerating because we saw inflation come down faster and so real wages continue to rise. When we think about workers' living standards, even though we're seeing that deceleration, living standards are increasing and have been for over well over a year now on average because inflation came down much faster," she said.