WASHINGTON D.C.: The U.S. labor market unexpectedly weakened in July as employers cut jobs and payroll figures for the previous two months were revised sharply lower, prompting investors to reduce expectations that the Federal Reserve will raise interest rates in September.

The Labor Department reported that nonfarm payrolls fell by 23,000 jobs last month, the first decline in five months. Economists surveyed by Reuters had expected payrolls to increase by 80,000 jobs after June's previously reported gain of 57,000. Estimates had ranged from 10,000 to 140,000 new jobs.

The government also revised May and June payrolls down by a combined 103,000 jobs, further softening the recent employment picture.

Despite the payroll decline, the unemployment rate edged down to 4.1% from 4.2% in June because 264,000 people left the labor force, pushing the labor force participation rate down to 61.4%, its lowest level since February 2021.

Economists cautioned against interpreting the report as evidence of a sudden deterioration in the labor market, noting that summer hiring data has repeatedly been distorted by seasonal adjustment challenges linked to the end of the school year.

"This is the third summer in a row that we have seen unexpected weakness in the labor market," said Stephen Stanley, chief U.S. economist at Santander U.S. Capital Markets. "Policymakers broadly see the labor market as stable."

Local government education employment fell by 49,600 jobs, contributing to a decline of 53,000 government positions overall. Excluding government employment, private payrolls increased by 30,000 jobs, matching June's gain. Some economists said private hiring offered a better measure of underlying labor-market conditions and expected government education payrolls to recover in August.

Leisure and hospitality employment fell by 40,000 jobs for a second consecutive month, with restaurants and bars shedding 26,100 positions. Retail employment also declined, losing 19,400 jobs, mainly at warehouse clubs, supercenters and other general merchandise stores.

Healthcare added 22,000 jobs, while construction gained 22,000 and manufacturing employment increased by 5,000, helped by continued investment in artificial intelligence infrastructure. Even so, the share of industries adding jobs slipped to 51.8% from 53.2% in June, suggesting hiring became less broad-based.

The report also highlighted continued pressure on labor supply. The labor force has fallen by more than 1 million people this year as the Trump administration's immigration crackdown reduced the number of available workers.

"Since January, the labor force has fallen by 228,000 persons per month and these individuals appear to have been foreign born," said John Ryding, economic advisor at Brean Capital. "It is hard not to attribute the decline in the labor force to immigration enforcement and policies. From the Fed's perspective, the labor market is at full employment and the economy cannot create jobs from people who are not here."

Household employment fell by 87,000, while the number of people working part-time for economic reasons increased by 123,000. The employment-to-population ratio also slipped to near a five-year low.

The report prompted financial markets to lower expectations for a September rate increase. According to LSEG data, traders now see a 44% chance of a rate hike next month, down from 57% before the report. The Fed left interest rates unchanged last week, although three policymakers dissented in favor of a quarter-point increase. Next week's inflation report is expected to play a key role in shaping the central bank's next decision.

"We agree that the July jobs report was a bit dovish on net," said Aditya Bhave, a U.S. economist at Bank of America Securities. "But we are sticking with our call that the Fed will hike by 75 basis points this year, starting in September. The Fed is likely to remain more focused on inflation than labor."