Should investors be worried about the U.S. labor market?

U.S. stocks have climbed in recent months, fueled by economic optimism and improving corporate earnings. But there’s a fly in the ointment: the U.S. labor market. Recent data have raised concerns that a hiring slowdown could tip the economy toward recession. Is this a serious risk, or is the job market actually stronger than it looks?

Investors have grown increasingly optimistic about the outlook for U.S. equities lately, thanks to the continued boom in artificial intelligence spending, expectations for renewed fiscal stimulus, and a belief that Federal Reserve rate cuts will keep the U.S. economic expansion intact.

But one nagging area of concern has been the loss of momentum in the U.S. job market. Given that consumer spending accounts for almost 70% of U.S. GDP, any softening in employment and income growth has direct implications for the strength of the overall economy and for corporate earnings growth. 

The most widely followed measure of labor market health is nonfarm payrolls, and the trend there has been unmistakably weaker. Payroll growth has been deteriorating steadily since mid-2021, and net job creation dipped into negative territory this past June—the first contraction in over three years.

As of late October, payroll data for September wasn’t available due to the federal government shutdown. But a more useful barometer of labor market conditions is the Kansas City Fed’s Labor Market Momentum Indicator, which combines 24 different labor market series to create a comprehensive, forward-looking measure.

By aggregating such a broad array of inputs—including hiring, wages, job openings, and participation trends—the momentum indicator provides a much richer view of the underlying direction of the labor market than payroll data alone.

The indicator weakened sharply in March but then bounced back, probably reflecting a temporary improvement after the Trump administration’s initial wave of federal job cuts. However, it never rebounded into positive territory and has since started to weaken again.

While the recent data warrant our attention, several developments suggest that labor market weakness may not be as ominous as it appears.

First, the Trump administration’s aggressive crackdown on illegal immigration has sharply reduced net immigration. Fewer entrants into the labor force mean fewer new jobs are needed simply to keep pace with population growth. So smaller payroll gains may not carry the same negative implications as they would if the U.S. labor force was growing faster.

Second, much of the recent softness in hiring has been concentrated in noncyclical sectors, such as health care, government, and education—areas where job growth often reflects sector-specific dynamics rather than broad economic conditions. 

If we separate these industries from the more economically sensitive cyclical sectors, we see an interesting pattern: Noncyclical industries were exceptionally strong through 2023 and 2024, masking weakness elsewhere. 

However, over the past several months hiring momentum has cooled in the noncyclical sectors, making the overall slowdown appear sharper even though cyclical industries have largely stabilized.

Finally, the layoff rate (the percentage of employed workers who involuntarily lose their jobs each month) remains low by historical standards. This suggests that while fewer new jobs are being created, employers aren’t cutting staff at an accelerating pace. In other words, the labor market appears to be moving from “very strong” to “moderately healthy,” not from “healthy” to “recessionary.”

The U.S. labor market clearly exhibits signs of weakness, but context matters. The slowdown appears to reflect normalization after an extended period of exceptional strength, rather than the onset of a major downturn. For now, we don’t view this as a precursor to recession.

Accordingly, the T. Rowe Price Asset Allocation Committee continues to maintain a broadly neutral risk posture while keeping a close eye on labor market trends that could influence the broader economic outlook.