The unemployment rate grabbed headlines, but wages, payroll revisions, and underemployment tell a much different story about the economy and the Fed.
KEY TAKEAWAYS
The headline unemployment rate improved, but payroll growth turned negative after substantial downward revisions to prior months. The labor market appears weaker beneath the surface than the headline suggests.
Wage growth continues to decelerate, falling from 4.0% to 3.2% over the past year. This steady decline may become one of the strongest disinflationary forces in the economy.
Underemployment remains elevated despite low unemployment. The availability of part-time workers seeking full-time employment suggests labor market slack still exists.
GDP growth slowed in the second quarter, but much of the weakness reflected lower government spending rather than deteriorating private-sector demand. Consumers and businesses continue to spend at healthy levels.
The Federal Reserve faces conflicting signals as cooling wages argue for easier policy while supply-side inflation risks and hawkish committee members continue pushing caution. September's inflation report may become the deciding factor.
MY HOT TAKES
Markets often become overly focused on headline statistics while missing the data that actually drives monetary policy. Investors should spend more time studying revisions and underlying trends than first-release headlines.
Wage growth deserves far more attention than unemployment when evaluating inflation risk. Labor costs frequently determine whether inflation becomes persistent or begins to fade.
Today's economy resists simple labels like recession or stagflation. Multiple economic forces are pulling in opposite directions simultaneously, making policy decisions unusually difficult.
Federal Reserve communication has become almost as important as Federal Reserve policy. Internal disagreement among policymakers creates uncertainty that markets may not be fully appreciating.
Investors should avoid making dramatic portfolio changes based on one economic report. Understanding the interaction among employment, wages, inflation, and growth produces better long-term decisions than reacting to headlines.
You can quote me: "Wages–not unemployment–are writing the Fed's next policy decision."
What’s good? Friday's jobs report handed the market a headline it liked and a body count it should have been scared of. Unemployment ticked down to 4.1%, which is great, if you don't look too closely. Payrolls didn't grow. They shrank! 23,000 jobs gone, against a Wall Street forecast of an +80,000 gain, with two prior months quietly getting revised down by over 100,000 jobs combined. That's not a rounding error, my friends. That's a labor market losing altitude while the headline number tells you it's climbing.
And here's the piece nobody's talking about: wages. Average Hourly Earnings grew a whopping two cents in July. Year-over-year wage growth slowed to 3.2%, down from 3.4% the month before–the second straight month of deceleration in a clearly declining trend. Add that to a Q2 GDP print that came in soft at 1.5%, down from 2.1% in Q1, and you've got the ingredients for a word the Fed won't say out loud: stagflation.
It is important to note that these numbers are not screaming "recession," nor do they warrant immediate evasive investment action. No. They are however displaying clear signs about just how complicated the economic picture is right now. Slow growth, a shrinking labor force (which is usually inflationary), slowing wage growth (which is always disinflationary), supply driven inflation from Middle East tensions / AI buildout / tariffs, and a new Fed Chair who wants to send the message that his Fed is a credible inflation-fighting force–but who has not quite found the words to effectively communicate all that just yet. It is confusing, and the market–near all-time highs–is not exactly sure what to make of all this. Let's have a closer look at what we know and get up to speed. Knowing right now–well, that's more valuable than knowing eventually. So let's dig in.
Start with the chart, because it tells the story faster than I can.
Take a look at Average Hourly Earnings, year-over-year, going back to last August. You're looking at a high of 4.0% on 8/31/25, and a low of 3.2% printed just last month, on 7/31/26. The average over that stretch sits at 3.6%. Draw a trendline through it–I did sloppily (my Mother would have punished me 😓), in red, right on the chart–and it's not choppy. It's not noisy. It's a clean, steady staircase down. Every few months it ticks up slightly, then rolls right back over and makes a new low. That's not a one-month fluke. That's a trend with conviction, and trends with conviction are the ones you build a thesis around.
Why does this matter more than almost any other number in the report? Because wages are upstream of inflation, not downstream of it. Every serious inflation model–from the Fed's own internal frameworks to the wage-price spiral logic that got us into trouble in the '70s–starts with the same basic mechanism: workers get raises, they spend the raises, businesses raise prices to cover the higher labor cost, workers demand bigger raises to keep up, and the wheel spins faster. That's how inflation becomes sticky instead of transitory. It feeds itself.
Run that mechanism in reverse and you get exactly what the chart is showing you. Wage growth cooling from 4.0% to 3.2% isn't a side effect of disinflation–it's a cause of disinflation, and one of the most reliable ones we have. If businesses are handing out smaller raises, they've got less pricing pressure to pass along, and the whole inflation engine loses a cylinder. On paper, that should be music to Jerome–sorry, old habit–to Kevin Warsh's ears. A new Fed Chair walking into the job with wage growth already cooling on its own is getting a gift most incoming chairs don't get.
So why isn't the Fed just declaring victory and cutting rates, or at least not threatening to raise them so emphatically?
Because wages are only half the picture, and the other half is muddier. Go back to that "shrinking labor force is usually inflationary" line I dropped in the intro. Here's the logic: when workers leave the labor force–retire, give up looking, whatever the reason–the supply of available labor shrinks. Less supply of anything, all else equal, tends to push the price of it higher. Applied to labor, that means fewer available workers should eventually put upward pressure on wages, because employers have to compete harder for a smaller pool. That's the classic tight-labor-market inflation story, and it's the one that kept the Fed hawkish for the better part of the last four years.
Except that's not what we're seeing right now, and this is where the underemployment number becomes the real aha moment in this whole report. The U-6 rate–the broader measure that includes not just the unemployed, but everyone marginally attached to the labor force and everyone working part-time purely because they can't find full-time work–sat at 8.0% in July, essentially unchanged from June. Buried inside that number: 4.8 million people are working part-time for economic reasons right now, and the majority of them say it's because of slack business conditions, not because they prefer part-time work. That's not a labor market starving for workers. That's a labor market with real slack sitting just below the surface, slack that the headline 4.1% unemployment rate is too clean and too narrow to capture.
So you've got two labor market signals pulling in opposite directions on inflation. A shrinking, less-participatory labor force that theoretically tightens things and pushes wages up. And a stubbornly elevated underemployment rate that says there's more available labor capacity than the headline number admits, which caps wage growth and keeps things loose. Which one wins? Right now, the wage data is casting the deciding vote–and it's voting for slack, not tightness. That 3.2% print, the lowest in this entire chart, is the market telling you the underemployment story is currently winning the argument against the shrinking-labor-force story.
Now overlay the GDP number, because it rhymes with everything else here.
Q2 GDP grew at 1.5%, down from 2.1% in Q1. On its own, that reads like confirmation of a slowing economy, and paired with the jobs report, it's easy to run straight to the recession headline. But–and this is the kind of nuance that separates an actual read of the data from a lazy one–most of that headline slowdown came from a pullback in federal government spending, not from the private economy losing steam. Strip that out and look at "real final sales to private domestic purchasers," which is about as clean a read as you get on actual private-sector demand, and that number actually accelerated, jumping to 3.9% from 1.7% in Q1. Translation: the government spent less, and that dragged the headline number down, while consumers and businesses were still spending at a healthy clip underneath it.
That's important context, because it means the "stagflation" word isn't a slam dunk case. You need both halves of that word to be true–stagnation and inflation–and right now we've got a headline growth number that looks stagnant-ish but a private economy that's still moving, next to a wage trend that's disinflationary and an underemployment number that says there's slack to burn before wages reaccelerate. It's not a clean stagflation setup. It's a genuinely confusing one, which is exactly why the Fed itself can't agree on what to do about it.
Which brings us to the Fed, and to Kevin Warsh's first real test.
At the July meeting, the Fed held rates steady–but three officials dissented, and they didn't dissent because they wanted a cut. They dissented in favor of a hike. That's the most hawkish FOMC dissent in roughly a decade, and it landed in the same month the jobs report showed payrolls shrinking. Sit with that for a second. You've got three sitting Fed officials looking at a labor market that just posted a negative payroll print and 100,000-plus in downward revisions, and their read is that the bigger risk is still inflation, not jobs. That's not a committee quietly leaning dovish behind closed doors. That's a committee that is genuinely split on which fire to put out first.
Warsh inherited that split, along with a market sitting near all-time highs that hasn't fully priced in how contentious this internal debate actually is. He wants the credibility of an inflation hawk. But he's chairing a Fed where the incoming data–especially that wage chart–is making the disinflation case for him, even as three of his own colleagues are publicly arguing the opposite. That's a communication problem as much as a policy problem, and it's part of why his public messaging has felt a little unsettled so far. He's trying to sound tough on inflation while sitting on data that's doing a lot of the tightening work by itself.
This week gives us the next data point that could tip the scale. July CPI drops Wednesday morning. If it confirms what the wage trend is already telling you–that price pressure is cooling from the supply side, not just the demand side–the doves inside that room gain real ammunition, and the case for a September move gets a lot easier to make. If it runs hot instead, the hawks who dissented in July get to say "told you so," and the Fed's internal argument gets even louder heading into the fall.
Either way, don't let the headline unemployment number do your thinking for you this week. The real story isn't 4.1%. It's a wage chart quietly grinding lower for eleven straight months, an underemployment rate stuck at 8.0% that most people never bother to check, and a Fed that's more divided about which economic disease to treat than the market currently appreciates.
Have I sufficiently confused you yet? It’s not intentional, I can assure you. I am just relaying the numbers that are the real tell about what is going on with the economy right now. Numbers that FOMC members have surely digested–hawks and doves. Will that affect their next policy decision in September? Well, that meeting is a long ways down the road–lots can happen in this highly charged environment. Futures markets have cut bets on a hike to slightly less than coin-toss odds. Those odds will surely change later this week when we get inflation numbers from BLS–which direction is anyone' s guess. Stay tuned–stay comfortable–this is not a short ride.
FRIDAY’S MARKETS
The S&P 500 rose 47.68 points to a record close of 7,757 on Friday, while the Nasdaq Composite jumped 1.30%, and the Dow Jones Industrial Average closed at 54,036. All three indexes finished the week higher, with the Dow capping a nearly 3% weekly advance, the S&P 500 up roughly 3.4% for the week, and the Nasdaq up nearly 4.9%. The rally came as investors bet the weaker-than-expected July jobs report would keep the Fed from hiking rates, sending the 10-year Treasury yield down 7 basis points to 4.6%. Stocks rose even as payrolls unexpectedly fell by 23,000 for the month.
NEXT UP
No economic releases today, but the remainder of the week is chock full of important earnings along with CPI / Consumer Price Index, PPI / Producer Price Index, Retail Sales, and University of Michigan Sentiment. It looks simple right here in this text, but you probably know already that it is far from simple, so make sure you check back in…a lot.
Cleveland Fed President Beth Hammack will speak this afternoon.