Labor market cooling, rate cuts coming

What happened?

The August employment report confirmed that the US labor market has slowed meaningfully over the summer. That said, the rate of hiring in and of itself is not alarming—it’s still quite healthy.

The economy added 142K jobs in August, an improvement from the 89K added in July (after negative revisions bringing it down from the originally reported 114K which spooked the market last month). That follows 118K jobs added in June (revised down from 179K). That brings the 3-month average to 116K, which remains quite solid. The economy could perform well for an extended period of time while adding an average of 100K–150K jobs/month. From here, though, the question is whether the pace of hiring levels off around this healthy level or softens to a less healthy level. The data to date cannot answer that question.

Implications for the Fed

With inflation back under control and slowly making its way back to the Fed’s target along with the labor market cooling, the Fed will be more than justified in cutting rates at their meeting on September 17–18. At the moment, it remains a close call whether they will cut by 25 bps or 50 bps. The futures market is currently pricing close to even odds of each of those outcomes.

Chair Powell has said that the committee neither seeks nor would welcome additional weakening of the labor market. Does this latest data meet the threshold of “additional weakening?” We don’t think it does. The incremental change relative to July was positive. Yet both June and July were revised lower, so the outright level of the labor market is weaker than at the beginning of summer.

We believe that the FOMC would prefer to start the cycle with a 25-bps cut and the latest data don’t convincingly make the case they must cut by 50 bps. That said, we think the neutral rate is well below the current rate and the balance of risks does support a larger cut. Accordingly, we believe they should cut by 50 bps. There’s no reason to have a policy rate this high in the current economic climate and with a slowing labor market; cuts should stabilize the economy at or around these levels rather than risking a more severe downturn.

Ultimately, the decision will be the Fed’s. We’ll keep an eye on the Fedspeak which emerges between now and the meeting, as well as on the inflation report on September 11, for any further insights into the pace at which they’ll want to cut.

Notably, the economy now appears to be in rough balance. Core inflation is annualizing just above the Fed’s 2% target, companies are hiring roughly the number of employees added to the labor force each month, and real wage growth is slightly positive. That’s not a bad place to be. Or, as we’ve put it in the past, we appear to have made it to the good place.