Rebecca Patterson is a senior fellow at the Council on Foreign Relations, a globally recognized investor, and macro-economic researcher.
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While the July U.S. jobs report Friday was surprisingly bad—sending U.S. equities, bond yields, and the dollar all sharply lower—the reasons behind the labor-market developments have been pretty easy to see. What remains murkier is how politics, such as President Donald Trump’s pressure campaign on the U.S. Federal Reserve and his sudden decision to fire the Bureau of Labor Statistics (BLS) commissioner, will affect the economy and markets in the future.
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The most recent jobs report [PDF] showed that non-farm employment rose by seventy-three thousand. That is a bit softer than expected, but the real shock came from the revisions to the previous two months: a reduction of 258,000 jobs. The unemployment rate rose from 4.1 percent to 4.2 percent in July, though economists noted the next decimal places which underscored a worrying trend upward (to 4.248 percent to be precise). Trump alleged without evidence that the numbers were “rigged” and made the extraordinary announcement that he had fired BLS Commissioner Erika McEntarfer in response.
But it’s a combination of government policy priorities—including immigration, government efficiency, and trade—along with the rapid development of artificial intelligence (AI) that explain a lot of what led to the ongoing slowdown in the U.S. labor market. This has also contributed to sticky wage inflation, which hasn’t yet followed the typical pattern of moderating in response to a cooling labor market.
To get to the core of the job report numbers, let’s start with immigration. President Trump campaigned on a pledge to strengthen the border and deport undocumented immigrants. Since taking office, deportations have indeed been ramping up. At the same time, programs to accept certain immigrants, enacted under President Joe Biden, are being wound down and U.S. border crossings have collapsed.
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Together, these policies have and continue to reduce the country’s labor supply. Undocumented immigrants make up about 5 percent of the U.S. workforce, with larger shares represented in industries such as agriculture, construction, and hospitality. According to Pew Research, undocumented immigrants and immigrants under a temporary humanitarian or asylum status in 2022 totaled roughly eleven million people.
This incremental reduction in the labor supply shows up in the economy in the unemployment rate and wages. If the supply of labor decreases while demand for labor slows by a similar amount, the overall labor market is said to be in balance. This has helped keep the unemployment rate between 4 and 4.2 percent for the past thirteen months.
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Meanwhile, fewer workers competing for jobs, all else equal, support wages. This was seen in average hourly earnings, which rose 0.3 percent in July. Including revisions to previous months, hourly earnings were up a healthy 3.9 percent from a year earlier.
Alongside immigration, the administration’s efforts to increase government efficiency, which has emphasized cutting the number of government employees, also helps explain recent labor-market trends. Government workers deciding to retire may be contributing to the slowing labor supply. And certainly, the job cuts influence total monthly payrolls. Federal government employment fell by twelve thousand in July and has dropped by eighty-four thousand since January.
Finally, the uncertainty around trade policy seems to be influencing business decisions around hiring broadly, but especially in the manufacturing sector. Not only did manufacturing jobs fall by eleven thousand in July, but sentiment in the industry remained very cautious. The Institute for Supply Management’s manufacturing sentiment index, also released Friday, fell by a point to forty-eight in July. It has been below fifty for five months, suggesting a modest contraction in manufacturing activity. A separate measure in the report for manufacturing employment fell to the lowest level in more than five years.
While government policy is playing a meaningful role in recent job trends, private-sector innovation is also worth considering. Specifically, corporate anecdotes and recent jobs data suggest that AI may be starting to reduce the number of needed entry-level workers in some sectors. The July report showed the number of new entrants—unemployed people looking for their first job—rose by 275,000 in July to 985,000.
Overall, the U.S. labor-market picture puts the U.S. Federal Reserve in a difficult spot. Fed Chairman Jerome Powell noted after the latest policy meeting [PDF] on July 30 that there were downside risks to the labor market, but with slowing job creation offset by a slowing in the supply of workers, “you’ve got a labor market that’s in balance.”
On inflation—the other half of the Fed’s mandate—Powell reiterated that the bank wanted to see more data to be confident that inflation was on track to reach its 2 percent target. He also wants more assurance that tariffs won’t result in sustained inflation, rather than a one-off price increase.
With jobs slowing and inflation still above target, the Fed will need to decide if the greater risk is cutting interest rates too late and risking a larger jobs slowdown, or cutting too soon and risking an inflation acceleration.
President Trump is vocally pushing for rate cuts now. And the latest policy meeting saw two Fed board governors, Christopher Waller and Michelle Bowman, agree that downside growth risks had become a greater concern.
By the end of the week, the investment community was also leaning more towards Fed easing interest rates at its next meeting in September. Indeed, about sixty basis points of rate cuts were discounted in Federal Funds futures pricing by year-end, suggesting at least two twenty-five-basis-point cuts. It’s not clear how much of those expectations are the direct result of the data and how much are the result of a growing sense that the president will keep taking exceptional steps to get the policy outcome he wants.
In response to a bad jobs report, Trump has fired a long-term government employee who received bipartisan backing to oversee the country’s labor-market statistics. He has flirted with firing Powell as part of his effort to pressure the central bank to lower rates regardless of the data. If trust in U.S. economic data and policymaking is eroded, it will likely result in investors demanding greater compensation for the risk embedded in U.S. financial assets—that would include higher government bond yields. This is a recipe for slower economic growth and even more challenging policymaking, whatever the data may say.
This work represents the views and opinions solely of the author. The Council on Foreign Relations is an independent, nonpartisan membership organization, think tank, and publisher, and takes no institutional positions on matters of policy.