The Labor Market Comeback May Not Be As Strong as It Looks

The narrative on the US labor market has pivoted from pessimism to optimism in recent months.

Last autumn, fears of labor market “downside risks” led to three cuts in the federal-funds rate (a total of 75 basis points). Job growth had plummeted, and the unemployment rate had started to tick up as well. But job growth came roaring back in the April and May 2026 job reports, helping shift market expectations on Fed policy, with the two-year Treasury yield rising by around 60 basis points since February 2026 as of early July.

We thought the narrative shift had gone too far, and the latest job figures (released July 2) sprinkled a bit of cold water on the optimistic narrative. Our best assessment is that the labor market is no longer weakening, as it was much of 2025. But it’s probably not strengthening either, and it remains in a slightly weaker than normal state.

When we say the labor market is slightly “weak,” we mean that it’s below full employment, which is one of the two prongs of the Fed’s dual mandate. For instance, the unemployment rate averaged 4.3% in the past three months, above our assessment of the natural rate of unemployment at 3.7%.

Job Growth Has Rebounded but Not As Much as Previously Thought

The latest data shows that nonfarm payroll employment grew at a 0.8% annualized pace in the three months ended in June (an average 111,000 jobs per month). That is considerably cooler than in last month’s jobs report, which showed three-month job growth at 1.4% annualized. The slower pace is due to the weaker pace of growth in June as well as this month’s downward revisions to the May and April data.

The downward revisions make sense, as last month we had argued that the unemployment rate should be falling much more rapidly if job growth was truly running in line with the nonfarm payroll figures.

But even with the new data, the 0.8% pace of job growth in the last three months considerably exceeds our estimate of “breakeven” job growth in 2026, at 0.35%. That means that the unemployment rate should steadily fall if job growth continues at current levels.

But in year-over-year terms (cumulative growth over the last 12 months), nonfarm payroll employment growth is just 0.3%. We think this slower-moving measure is a better gauge of the trend in job growth. At 0.3%, this rate of growth is about in line with our breakeven job growth estimate.

The unemployment rate is no longer rising, but neither is it clearly trending down. It had reached 4.4% in the three months ended January 2026, gradually climbing from 3.5% in May 2023. It currently stands at 4.3%.

Wage growth remains subdued, at 3.5% year-over-year in June (three-month average). That argues against the notion that the labor market has tightened substantially. Our composite measure of wage growth also stood at 3.5% year-over-year in the first quarter of 2026.