Labor Market Data Looks Strong, but Cracks Are Forming, Economist Warns

Last Friday’s jobs report was upbeat, but the numbers might not be telling the whole story, one economist warns.

Samuel Tombs, Chief US economist at Pantheon Macroeconomics, sees a labor market struggling with softening hiring and an accelerating trend of downward revisions.

In May, 139,000 jobs were added, beating the 125,000 consensus estimate, but that was overshadowed somewhat by sharp revisions to prior months’ data. March’s initial figure of 224,000 payrolls added has since been nearly slashed in half, down to 120,000.

It’s likely that May’s figure is inflated, too, Tombs said.

“We expect May’s number to be revised down to about 100,000 by the third estimate, published in early August,” Tombs wrote in a recent note.

Since January 2023, downward revisions between the intial and third estimates for each month have averaged 30,000.

The frequency of downward revisions could be due to reporting by small businesses filing payroll data late, Tombs said. Smaller companies are often hit the hardest by high interest rates and tariff costs.

“Small businesses are really the canary in the coal mine in this downturn,” Tombs told BI. “They don’t have the financial capacity to deal with many of the upfront costs that are involved with tariffs. They still face very high borrowing costs, so they are very, very cautious with both their hiring and capex decisions going forward.”

Tombs sees continued weakness in the retail, wholesale, and transport and logistics sectors, and expects employment in those parts of the economy to fall by 50,000 by year-end due to a reduction in the “pull-forward effect” from tariffs, which saw many businesses and consumers rush to spend money ahead of tariff-related price hikes.

On top of the revisions, hiring also appeared poised to slow. The NFIB small business hiring intentions index slipped to its lowest level since May 2020, and regional Fed surveys suggest continued declines in service-sector employment outside healthcare and education.

“Of all the indicators that we track, it is the best singular indicator of payroll growth that we’ve found in the last three years,” Tombs said of the NFIB survey.

In the chart below, hiring intentions tracked by regional Fed surveys are weaker than the 2015 to 2024 average. Actual job growth in the private services sector tends to move closely with hiring intentions, meaning that when hiring intentions fall, actual hiring tends to drop shortly after.

Tombs believes government jobs will also continue to decline after their DOGE gutting as federal employees who accepted a voluntary buyout get removed from the payroll in September — they’ve fallen by 59,000 this year, including by 22,000 in May.

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On this trajectory, Tombs expects the unemployment rate to peak at 4.8% by December.

This year, the Fed has been in wait-and-see mode when it comes to cutting rates, and some strategists believe it’s prioritizing bringing inflation down before turning to expansionary monetary policy. But these factors point to a labor market that’s weaker than it seems, and Tombs believes the Fed will need to start cutting rates in September to provide relief for businesses, before inflation peaks.