WASHINGTON — U.S. nonfarm payrolls unexpectedly contracted in July, breaking expectations of modest growth and stirring fresh debate over the trajectory of the American economy and future Federal Reserve policy.

According to data released by the U.S. Bureau of Labor Statistics on Friday, nonfarm payrolls fell by 23,000 last month. The reading sharply diverged from the consensus forecast gathered by Dow Jones, which had anticipated an increase of 81,000 jobs.

Adding to the bleak picture, the labor department significantly revised down employment figures for the previous two months. May’s job gains were adjusted lower by 66,000—from 129,000 to 63,000—while June’s figures were trimmed by 37,000, from 57,000 to 20,000. Combined, the revisions revealed that the economy created 103,000 fewer jobs than previously reported in May and June.

Sectoral data highlighted widespread weakness. Local government education led the decline, shedding 50,000 positions. Retail trade employment contracted by 19,000, and financial activities dropped by 14,000, extending a downward trend that began in May of last year. Although healthcare added 22,000 jobs, the gain fell below its 12-month average of 36,000.

Despite the job losses, the unemployment rate ticked down to 4.1% from 4.2% in June, coming in slightly below market expectations. However, analysts pointed out that the decline was largely driven by a contraction in the labor force rather than organic hiring. The labor force participation rate slipped to 61.4%, marking its lowest level since February 2021 during the height of the pandemic.

Wage growth also showed signs of cooling. Average hourly earnings rose just 0.1% month-over-month and 3.2% from a year earlier, both missing estimates of 0.3% and 3.5%, respectively. The muted wage growth suggests that inflationary pressures emanating from the labor market remain subdued.

The disappointing report immediately triggered a rally in U.S. Treasuries as investors recalibrated expectations for Federal Reserve monetary policy. The yield on the policy-sensitive 2-year Treasury note fell 7 basis points to 4.17%, while the benchmark 10-year Treasury yield declined 5 basis points to 4.62%.

Market observers noted that the data points toward a cooling labor market, dampening expectations for further aggressive interest rate hikes by the central bank.

Stephanie Roth, chief economist at Wolfe Research, remarked that the underlying labor market is weaker than earlier reports suggested, adding that while seasonal factors likely played a role, the broader trend points to clear deceleration. She noted that if upcoming economic indicators, particularly inflation data, continue to print soft, the Federal Reserve will likely refrain from further rate increases.