Employment report July 2026

A disinflationary labor market, but one to watch

• The July jobs report was notably weaker than expected, with payrolls declining 23,000 and the prior two months revised down by a combined 103,000. A large seasonal swing in government education payrolls masked a modest 30,000 gain in private payrolls, but underlying job creation was increasingly narrow as services hiring weakened noticeably. The three-month average pace of payroll growth slowed to a modest 20,000, reinforcing the view that the labor market is still moving forward but with softer momentum and a narrower base of job gains.
  
  
• At first glance, the weak payroll picture appears at odds with the decline in the unemployment rate. The unemployment rate fell to 4.1% in July – its lowest level since January 2025 – while the labor force participation rate edged down to 61.4%, reflecting another contraction in the labor force. But the lower unemployment rate should not be mistaken for stronger labor market momentum. As labor force growth slows, the economy needs fewer jobs than in the past to keep unemployment from rising even as hiring cools.
  
  
• Beyond the softer hiring data, wage trends also pointed to easing labor market pressures. Wage growth eased 0.3 percentage points (ppts) to 3.2% year over year (y/y) in July, with average hourly earnings rising just 0.1% on the month. That follows yesterday's productivity report, which showed unit labor costs increasing at a modest 1.3% annualized pace for a second consecutive quarter. Taken together, the data confirms that labor costs are not fueling broader inflation pressures.
  
  
• The labor market is still moving along, but it’s increasingly challenging to navigate. Layoffs and unemployment are low, yet hiring and job mobility have slowed markedly. The result is a labor market that looks stable in the aggregate but feels much tougher for recent graduates, new entrants and workers seeking better opportunities. Businesses remain highly selective, hiring only where skills needs are most acute while keeping a close eye on costs.
  
  
• For the Fed, the July jobs report sends a mixed signal. On one hand, softer job growth and cooling wage pressures reinforce the view that the labor market remains disinflationary. At the same time, this is a labor market with fragile stability that warrants monitoring. Policymakers will want to ensure that softer hiring does not evolve into a more meaningful deterioration in labor market conditions.
  
  
• Ultimately, with Fed officials on high inflation alert, next week’s Consumer Price Index (CPI) report will likely carry more weight for the September decision than today's employment data. With another CPI report, a personal consumption expenditures (PCE) report and an additional jobs report still to come, policymakers will have plenty of data ahead. Our base case remains that the Fed stays on hold through year-end, though the risk of a rate hike remains elevated. A string of firmer core inflation readings over the coming months would strengthen the case for tightening.

A labor market of selective hiring

Hiring momentum softened in July, though private-sector job creation remained positive. Private payrolls rose by 30,000 for a second consecutive month while government employment fell by 53,000, driven largely by a 50,000 decline in local government education payrolls. That drop reflects seasonal distortions associated with the end of the school year. Public education payrolls typically fall sharply in June and July as schools recess and many teachers on 10-month contracts temporarily come off payrolls before returning in September.

More broadly, the three-month average pace of private payroll growth slowed from 80,000 to 40,000 in July, underscoring a labor market that is still creating jobs but at a more modest pace. Consistent with that trend, the private-sector diffusion index edged down to 51.8 from 53.2, signaling that job growth was less broad-based across industries.

That narrowing in hiring was evident across sectors. Healthcare remained a key source of job creation, adding 23,000 jobs, though hiring continued to moderate from the stronger pace seen last year. Professional and business services added 18,000 jobs and appears to be regaining momentum after shedding roughly 160,000 jobs in 2025. Construction (+22k) and manufacturing (+5k) also posted gains, suggesting some stabilization in parts of the goods-producing sector.

Outside these gains, labor demand remained subdued. Leisure and hospitality shed 40,000 jobs, extending a recent loss of momentum in a sector that had been a major contributor to post-pandemic job growth. Retail trade (-19k) and financial activities (-14k) also weakened, likely reflecting continued consumer caution and ongoing efforts by firms to boost efficiency and control costs. Taken together, the industry mix suggests hiring remains highly selective, with businesses adding workers primarily where labor shortages persist or demand remains structurally strong.

The views reflected in this article are the views of the author(s) and do not necessarily reflect the views of Ernst & Young LLP or other members of the global EY organization.