The Federal Reserve is showing increasing reluctance to commit to an autumn interest-rate cut, balancing the risks of premature action against rising inflation pressures. This cautious stance reflects the surprising resilience of the U.S. economy despite recent labor market data indicating potential weakness in the months ahead.
Labor Market Signals Shift in Fed Policy
Recent labor market data suggest a shift in the Fed’s policy stance. The likelihood of a September rate reduction is rising, driven by expectations of further economic loosening by year-end. Fed Chairman Jerome Powell hinted at this change on July 31, suggesting that risks to the central bank’s mandate are reaching “better balance,” signaling a potential pivot.
Wall Street interpreted Powell’s remarks as an acknowledgment of the weakening labor market, a key area of the Fed’s dual mandate alongside price stability. Powell noted that the labor market is “normalizing” after an extended period of overheating, with the unemployment rate holding at or below 4% for a record 27 months.
Fed Ready to Act on Labor Market Changes
Powell emphasized the Fed’s readiness to respond to labor market conditions. “We are watching labor market conditions closely, and if we see significant changes, we are well-positioned to act,” he stated.
So far, labor market indicators are not promising. The Labor Department reported that weekly jobless claims surged to their highest level in nearly a year by July 27, with around 250,000 Americans filing initial unemployment claims. Continued claims, which lag by a week, reached 1.88 million, the highest since 2021.
Slowing Hiring and Rising Layoffs
Hiring is also decelerating sharply. Challenger, Gray & Christmas reported that employers planned to add only 3,676 workers in July, bringing the year-to-date total to 73,596, the lowest in over a decade. Job cuts are increasing, with the highest July tally in four years and the third-highest year-to-date total since 2009.
The Institute of Supply Management’s manufacturing PMI survey revealed that the proportion of managers expecting hiring to slow is at its highest in nearly two years. “Respondents’ companies are reducing head counts through layoffs, attrition, and hiring freezes,” noted ISM Chairman Tim Fiore.
Economists project a gain of 148,000 new jobs in July’s nonfarm payrolls report, but wage growth is expected to remain subdued. Wall Street anticipates average hourly earnings growth to slow to around 3.7%, with monthly wages rising 0.3% and the headline unemployment rate holding at 4.1%.
Easing Wage Gains and Fed’s Next Move
Earlier this week, payroll processor ADP reported 122,000 new private-sector hires in July, below expectations, with wage growth slowing to its weakest pace in three years. “With wage growth abating, the labor market aligns with the Fed’s effort to control inflation,” said Nela Richardson, ADP’s chief economist.
A separate report on unit labor costs in Q2, closely watched by the Fed, showed the smallest increase in three years. Powell suggested that a rate cut “could be on the table as soon as the next meeting in September” if labor market steadiness and easing inflation pressures persist.
However, some analysts worry that the Fed’s delay in adjusting rates might have kept them too high for too long, hindering the job market’s natural adjustment. With the Federal Funds rate at a 22-year high of 5.25%-5.5% for the 12th consecutive month, businesses face tight credit conditions and are scaling back expansion plans.
Market Reactions and Future Prospects
Traders are increasingly betting on a September rate cut, with CME Group’s FedWatch tool indicating a 64% chance of a year-end Federal Funds rate of 4.5%-4.75%. Benchmark 10-year Treasury note yields have fallen below 4% for the first time since February, while 2-year notes dropped to a six-month low of 4.209%.
Economists at Renaissance Macro Research warned, “The ongoing deterioration in economic data suggests we are nearing a point where bad economic news negatively impacts markets.” They added, “Until the Fed begins cutting, they risk appearing behind the curve. However, this is a small policy error that can be corrected swiftly.”
Key Takeaways:
- The Fed is cautious about committing to a rate cut due to inflation concerns and economic resilience.
- Recent labor market data point to potential weakness, bolstering the case for a September rate reduction.
- Jobless claims are rising, hiring is slowing, and layoffs are increasing, signaling a cooling labor market.
- Wage growth is easing, aligning with the Fed’s inflation control efforts.
- Market expectations for a rate cut are rising, with potential implications for economic and market stability.
Conclusion
The Federal Reserve’s balancing act between controlling inflation and supporting the labor market is becoming more precarious. As labor market indicators weaken, the likelihood of a September rate cut increases, raising questions about the timing and impact of the Fed’s next moves on the broader economy and financial markets.
