A Weak Jobs Report Signals Stagflation. Blame Tariffs.

Recruiters and job seekers at a job fair in Chicago on June 26. (Jamie Kelter Davis/Bloomberg)

Kill the messenger. After a weak July employment report, President Donald Trump Friday added the head of the Bureau of Labor Statistics to the ranks of the unemployed.

But the softer jobs numbers aren’t a portent of recession. Instead, they signal the onset of stagflation—the result not of the Federal Reserve’s interest rates but the Trump administration’s tariff policies. The uncertainty after “Liberation Day” in April has been followed by a sharp slowdown in hiring.

Data released on Friday morning showed that nonfarm payrolls rose 73,000 in July, about 30,000 jobs shy of the consensus guess from economists. The real shock was a massive, 258,000 downward revision in the prior two months’ totals.

Prior to the jobs report, Trump had let loose a barrage of criticism of Federal Reserve Chair Jerome Powell for not cutting interest rates. Unable to fire the head of the central bank, the president instead directed that the BLS commissioner, Erika McEntarfer, be sacked. In an online post, Trump claimed that the “Biden Appointee” “faked” the jobs numbers ahead of last year’s election but was responsible for large revisions in initial estimates.

Revisions in the key payrolls data to some degree may be traced to the declining response rate among businesses to the BLS’ monthly surveys, according to economists who watch the data. The BLS also points out that the confidence interval for the payroll number is plus or minus 136,000. That means the latest report could have shown a 209,000 increase or a 63,000 decrease, with a 90% probability. That’s out of a labor force of 170 million.

That said, the main number to watch now is the unemployment rate (derived from a separate survey of households), said Powell at his Wednesday afternoon news conference after the central bank’s two-day policy meeting, at which there was no rate change, as expected. The jobless rate ticked up by 0.1 percentage point to 4.2%, as expected, which reversed the previous month’s drop.

The unemployment rate shows that the job market is in balance, as both the demand and supply of jobs have been declining in tandem, Powell said. But a jobless rate in the low 4% range indicated the Fed’s was closer to its maximum employment mandate while inflation remains above its 2% target.

The core personal consumption expenditures gauge, which excludes food and energy prices, was up 2.8% in the 12 months through June, higher than Powell estimated at the news conference. Over the past six months, core PCE inflation has run at a 3.2% annual rate, up from 2.2% last fall, noted Michael Darda, chief economist and market strategist at Roth Capital Partners.

But the miss on the jobs numbers put a September Fed rate cut back in play. A quarter-point cut from the Fed’s current federal-funds target range of 4.25% to 4.50% was given an 81% probability by the futures market on Friday, according to the CME FedWatch site. That was more than double the 37.7% probability just a day earlier, reflecting the relatively hawkish tone taken by Powell at his presser.

The latest month’s data superficially resemble the year-ago pattern, which saw weaker-than-expected July jobs leading to a bigger-than-expected half-point Fed rate cut. What’s different this time, according to Komal Sri-Kumar, president of Sri-Kumar Global Strategies, is Liberation Day. U.S. companies have been in doubt about how much of the tariffs were going to stick, he said in interview.

That uncertainty initially has led to a low level of hiring, but not much firing. So far, sackings haven’t been evident at the unemployment offices. Initial claims for jobless benefits have averaged 221,000 per week over the past four weeks, a historically low level.

Ahead is the second stage with poor hiring, rising layoffs, and a rising jobless rate as companies deal with price pressures, Sri-Kumar continued. Average hourly earnings have accelerated sharply, to a 3.9% year-over-year rate of increase, he noted. The Employment Cost Index, Powell’s favored labor cost gauge, was up 3.6% in the second quarter from a year earlier.

To counter the squeeze on profit margins, he sees more companies, such as Procter & Gamble, pushing up prices. P&G said in its earnings call this past week that it looked to hike prices on about 25% of its ubiquitous household products.

The cost pressures are evident in a $30 billion drop in corporate tax revenue, writes Joseph Carson, former chief economist of AllianceBernstein, in an email. While the federal government may be garnering extra revenue from tariffs, U.S. firms are covering the cost, resulting in lower tax payments.

Sri-Kumar says that the weak jobs growth as a reaction to the price pressures isn’t the Fed’s fault. “It wasn’t Powell who imposed the tariffs,” he said.

Nevertheless, short- and intermediate-term bond yields moved sharply lower on Friday in anticipation of a Fed rate cut next month. The two-year Treasury note yield, the maturity most sensitive to anticipated Fed moves, fell a quarter percentage point, to 3.708%, a three-month low. But longer-term yields fell much less, with the benchmark 10-year yield down 0.15 percentage point, to 4.225%, just back to where it traded at the end of June.

Sri-Kumar contends that even if the Fed cuts, bond yields ultimately are heading sharply higher. He sees the 10-year hitting 5% by year end, while the 30-year long bond rises to 5.75% from 4.80%, a pattern similar to late last year when the Fed lowered rates by a full percentage point.

Markets will be vulnerable to stagflation, regardless of who might get sacked in Washington.

Write to Randall W. Forsyth at randall.forsyth@barrons.com