Hopes of September rate cut rise after US payrolls data
After Friday’s jobs data raised concerns about a weakening US labour market, the chances of a September rate cut have risen noticeably.
June payrolls point to weakness in US labour market
Friday’s payrolls data showed that the US added 206,000 jobs in June. While this was above the expected 191,000, it was down on May’s 218,000. That last number had itself been revised sharply lower, down from the initial 272,000 figure.
In addition, the unemployment rate rose slightly, to 4.1%, above the expected 4%, and the highest reading since December 2021. Meanwhile, average hourly earnings rose 3.9% in June compared to a year earlier, the slowest pace of growth in a month.
September cut more likely?
Data from the CME’s FedWatch tool showed a sharp increase in expectations for a September rate cut by the US Federal Reserve (Fed). A rate cut of 25 basis points (bps) is now viewed as being a 69% chance, compared to 46% a month ago.
While the latest jobs report suggests a more balanced labour market, the Fed must carefully weigh the timing of potential interest rate cuts. Although July seems premature, a favourable inflation report could bolster arguments for a September cut.
The unemployment rate, though still relatively low at 4.1%, has risen from its early 2023 levels, potentially signalling that the labour market in the US is now beginning to deteriorate meaningfully.
Tricky path for the Fed
The Fed must navigate the delicate balance between cutting rates too soon, risking persistent inflation, and acting too late, potentially exacerbating labour market weakness. Complicating matters further are ongoing pandemic-related distortions and increased immigration.
Job growth has primarily occurred in healthcare, government, and leisure/hospitality sectors, largely as a post-pandemic catch-up. Once these sectors have filled up the vacancies available, overall job growth may begin to slow dramatically.
How many cuts this year?
The Fed’s median estimate is still for one cut this year, though some policymakers on the Federal Open Market Committee (FOMC) still argue for two. Essentially, we continue to wait to see if the labour situation worsens from current levels.
What is still fairly certain is that a recession does not appear to be on the cards. Thus, while the Fed is likely to begin cutting rates in coming months, it will be for ‘good’ reasons, i.e. supporting the labour market and consumers, and be done at a steady pace of 25bps for each cut.
This differs from a ‘bad’ rate cut, done in haste to shore up an economy that is in serious trouble. Usually these cuts are more dramatic, and can often cause a risk-off move in markets as investors fret about the economic outlook.
Overall, the Fed thinks the time is nearly right to cut rates by a small amount, and hint at more. Rate hikes remain off the menu, and this is an environment likely to see further gains in US, and indeed global, equity markets.
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