Cooling US job market will set the pace of rate cuts as recession fears loom
Employment creation in August was weaker than expected, according to the latest report from the Bureau of Labor Statistics, which could lead to the Fed slashing rates by half a point instead of a quarter point
The U.S. economy continues to avoid recession despite all the bad omens, but the weakening of the labor market continues, putting pressure on the Federal Reserve to cut rates aggressively. Job creation accelerated somewhat in August after the poor July figures, and the unemployment rate fell by a tenth of a percentage point, from 4.3% to 4.2%. But 142,000 nonfarm jobs were created during the month, according to Friday’s report from the Bureau of Labor Statistics. Economists had expected 164,000 jobs to be created instead. In addition, the June and July figures are revised downward.
The cooling of the labor market marks the evolution of the world’s leading economy and will be a key factor in the depth of the interest rate cut that the Federal Reserve plans to approve at its meeting on September 18. Following the publication of the employment data on Friday, Fed funds futures quotes have assigned an implied probability of 59% for the September 18 rate cut to be 0.50 percentage points and 41% for a smaller cut of 0.25 points from the current range of 5.25%-5.5%. Until today, the clear majority was betting on a 0.25 point cut, which means that the unemployment data has changed investors’ expectations. Short-term debt yields are also reflecting this with a drop.
Expectation had been huge after the July report showed a greater-than-expected weakening of the labor market, triggering an earthquake in the stock markets. Investor jitters were evident already this week when the number of job openings fell to 7.7 million, the lowest since January 2021, according to data released on Wednesday, which disappointed expectations. This Thursday, however, the jobless claims figure met expectations and remained at historically low numbers.
At the Jackson Hole gathering at the end of August, Federal Reserve Chairman Jerome Powell had expressed confidence in the chances of achieving a soft landing for the economy, i.e., bringing inflation towards the 2% target without the sharp rise in unemployment associated with a recession. He stressed the “ample room” to lower rates now that “the time is ripe.” Critics believe that the time came as early as July and that the central bank is somewhat behind the curve, but many economists are confident that the U.S. economy can once again avoid a recession that has been forecast for more than two years.
Unemployment has risen so far because of the increase in the labor force and not because of job destruction. Moreover, most of those who lose their jobs manage to find another position later on, which explains why there are few initial claims for unemployment benefits. “A key risk to our forecasts of a soft landing in the labor market is that outplacement rates decline, leading to a rapid rise in initial claims and the number of permanently unemployed, which would set in motion a vicious cycle of lost earnings, reduced consumer spending and further job losses as businesses contract,” note analysts at Oxford Economics.
Indicators of industrial and services activity also give somewhat mixed readings, and the Fed’s Beige Book on Wednesday showed signs of weakening activity in much of the country, but at the same time indicated that layoffs were rare for the time being. At that inflection point, the August employment data (and the revision of the June and July figures, which are released at the same time) should weigh in on the debate.
Economists had been expecting the household survey to show a drop in the unemployment rate to 4.2% in August from 4.3% in July. At the same time, they expect the business survey to show 164,000 jobs created last month, accelerating from the 114,000 jobs that spooked the market five weeks ago and were somewhat affected by temporary layoffs, Hurricane Beryl and heat waves. An increase in unemployment against the forecast would set off all the alarms that the economy is heading into a recession.
At the September 18 meeting, Fed members will not only decide on the size of the first rate cut in four and a half years, but will also give their forecasts — non-binding and often unenlightening — of where they expect the federal funds rate to stand at year-end.
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