Steady job market keeps Fed on hold amid tariff uncertainty

• US job market defies expectations of deterioration
• Labor data closes door on July Fed rate cut
• Traders now see just two Fed rate cuts by year-end

By Ann Saphir and Howard Schneider

July 3 (Reuters) - Unexpectedly solid job gains in June bolstered the case for the Federal Reserve to keep interest rates on hold to keep downward pressure on inflation, with one U.S. central banker saying it could take a year or more for the economy to adjust to the Trump administration's tariff and other policies.

"The main punchline is that the adjustment of prices and the broader economy to changes in trade and other forthcoming policies in the United States, along with geopolitical developments, is not going to be a short and simple one-time shift in prices, as standard textbook models would suggest," Atlanta Fed President Raphael Bostic said in remarks to an economic conference in Germany.

"If I’m right, then the U.S. economy will likely experience a longer period of elevated inflation readings," that will keep the Fed patient before cutting its benchmark policy rate, Bostic said. The Fed "must await more clarity" on inflation, economic growth and jobs before easing monetary policy.

The labor market, at least for now, receded as a risk when new data on Thursday showed U.S. firms added a more-than-expected 147,000 jobs in June and the unemployment rate unexpectedly fell to 4.1% - another sign that the economy remained resilient despite the turbulence and uncertainty over how big tariffs will be.

President Donald Trump has demanded immediate rate cuts, but Fed officials have said that with inflation risks rising there is no need to ease policy unless the job market begins to weaken in a significant way.

New inflation data will be released in about two weeks, and Fed Chair Jerome Powell has said that if inflation does rise due to tariffs it will likely begin happening this summer.

The jobs data, meanwhile, undercut the case for a rate reduction as soon as the Fed's upcoming July 29-30 meeting, a possibility raised in recent weeks by Fed Governor Christopher Waller and Fed Vice Chair for Supervision Michelle Bowman, who had called for early action to head off labor market deterioration.

"Today’s data of higher-than-expected payrolls, a drop in the unemployment rate, and a fall in jobless claims completely dispels their case for imminent rate cuts and implies that there is absolutely no urgency for Fed support," said Seema Shah, chief global strategist at Principal Asset Management. "We expect the first cut to come in late 2025."

Bostic has also said he anticipates just a single rate reduction this year; recent projections from Fed officials see two cuts.

The Fed last month left its benchmark overnight interest rate in the 4.25%-4.50% range, where it has been since December. The decision has drawn fury from Trump, who feels that recent weak inflation means the central bank should be sharply reducing its policy rate. He has asked Powell to resign.

Treasury Secretary Scott Bessent, reportedly under consideration as a possible Powell replacement, told CNBC that the jobs number was "good" and that "thus far we haven't seen any inflation from tariffs."

"If they want to make a mistake here and not cut, that's fine," Bessent said of Fed policymakers, adding that forgoing a rate cut now increases the chance that the Fed will cut by a half-percentage point in September.

Powell, who has said he intends to serve out a term as chair that ends on May 15, on Tuesday reiterated the central bank's plans to "wait and learn more" about how much tariffs push up on inflation before lowering rates again.

Rate futures show traders are back on board with that vision, with financial market bets pointing to a September start to rate cuts and a total of just two quarter-point reductions by year-end, not the three rate cuts that they had earlier favored.

Despite June's unexpectedly large increase in payrolls, Thursday's data continued to show the labor market is cooling.

Average earnings rose 3.7% in June, coming further into line with what Fed policymakers feel is consistent with their 2% inflation goal.

Broadly the report contained plenty of evidence that the Trump administration's trade and other policy changes are reshaping the job market. Manufacturing jobs fell by 7,000, and federal government payrolls also slipped.

Restrictions on immigration and the administration's push for deportations also look to be reducing the share of foreign-born workers in the job market.

In a poor sign for the outlook, hiring was concentrated in an increasingly narrow range of job types.

Labor force participation continued to fall in June, dropping a tenth of a percentage point to 62.3%, after falling two tenths of a percentage point in May.

Without those declines, the unemployment rate would have risen to 4.7%, wrote Nationwide's Kathy Bostjancic, who attributed the job market exits to potential workers becoming too discouraged to look for jobs, or to reductions in immigration.

Characterizing the employment report as "weak," Bostjancic said it "supports our view that the Fed will cut the fed funds rate by 75 bps by year-end to bolster a slowing economy despite a likely temporary run-up in prices stemming from tariffs," she wrote.

A separate report on Thursday from the Institute for Supply Management showed the U.S. services sector picked up in June, though employment contracted, with businesses hesitant to fill jobs, highlighting the economic drag from policy uncertainty.

Manufacturing jobs

Trump immigration policy begins to shape the job market

Average hourly earnings growth