In a significant change of narrative, the Federal Reserve is shifting its focus from inflation to the labor market, signaling a stronger emphasis on job growth. This shift comes in light of the July nonfarm payrolls report, which revealed softer-than-expected jobs growth and a steady increase in the unemployment rate. As a result, concerns of a slowdown and potential recession have gained traction.

Previously, policymakers grappled with the challenge of rampant inflation in the United States. However, this year has seen a cooling trend in consumer prices, making inflation a virtually non-issue at present. Jeremy Schwartz of WisdomTree noted that inflation is below 2% when applying real-time shelter price data to consumer price index (CPI) calculations. Additionally, the "Truflation" indicator, as coined by Mike Zaccardi from Seeking Alpha, is near cycle lows at around 1%.

Several factors have contributed to the decline in inflationary pressures. Falling wage growth levels, along with increased worker productivity this year, have brought inflation closer to the desired 2% target. Furthermore, the drop in commodity prices and instances of outright deflation in China have played a role in cooling the global inflation trend.

The pivotal moment in this shift towards prioritizing the labor market over inflation occurred with the release of the July employment situation report. The data from the U.S. Bureau of Labor Statistics showed a significant shortfall in nonfarm payrolls, with only 114,000 jobs added compared to the expected 180,000. The report also revealed an uptick in the unemployment rate, reaching 4.3%.

This employment situation report triggered the adoption of the "Sahm Rule," named after Claudia Sahm, a macroeconomist who previously worked at the Fed and the White House's Council of Economic Advisers. According to this rule, an early-stage recession is indicated when the three-month moving average of the unemployment rate is half a percentage point or more above the lowest three-month moving average rate of the previous 12 months. The July report raised concerns about the economy, leading to a notable decline in the stock market.

However, the August employment situation update did not bring much improvement. The data showed softer-than-expected jobs growth for the month, along with downward revisions to the June and July figures.

All eyes are now on the next meeting of the Federal Open Market Committee (FOMC), where the monetary policy committee is widely expected to initiate its easing cycle by announcing the first interest rate cut since 2020. The size of the rate cut is currently a topic of debate, with expectations ranging from a front-loaded 50 basis points to a total of 100 basis points in policy rate cuts.

As the balance of risks in the United States shifts, with easing inflation pressures and decelerating job growth, experts believe that the FOMC is moving away from its mid-year gradualism guidance. Bruce Kasman from JPMorgan forecasts a 50 basis point cut in the upcoming meeting and anticipates a total of 100 basis points cuts in the near future.

With the labor market taking center stage, the Federal Reserve's dual mandate of maximum employment and stable prices remains the primary focus. As the U.S. economy navigates through uncertain times, policymakers hope that a shift in emphasis towards fostering job growth will counterbalance any potential economic downturn.