Locked In Rate Cuts
Key Takeaways
A Rate Cut Is Imminent Possibly Larger Than Expected
The weak August jobs report (22,000 new hires) all but guarantees a Fed rate cut in September. While markets expect the typical 0.25% move, the Fed could opt for a larger 0.5% cut to offset slowing growth and address political criticism.
Tariffs Are Weighing on Hiring and Growth
Uncertainty around tariffs and trade rules has led many businesses to pause hiring, slowing job creation despite low layoffs. Growth has decelerated, but recession risks remain low as corporate profits and household finances remain strong.
Fed Balancing Act: Stimulus vs. Inflation Goals
While cutting rates would provide support and ease political pressure, it risks overshooting the Fed’s 2% inflation target. A larger cut could deliver a psychological boost to markets and policymakers without meaningfully changing the economy’s current solid foundation.
A weak jobs report of just 22,000 net hires in August locks in a rate cut at the upcoming September FOMC meeting, which is pretty much already priced into the market. But we think they may go by 0.5% instead of the more typical 0.25%, which is not priced in. It would be cheap insurance against a weakening pace of growth and might temper the severe criticism of the Fed by politicians.
If there was any doubt about the next policy action of the FOMC after Chairman Powell’s speech in Jackson Hole, it was resolved by the latest jobs report. While the voting status of a number of Fed officials remains uncertain, including Lisa Cook and Stephen Miran, the rest of the FOMC is highly likely to vote to cut rates. But the FOMC could choose to move by a half percentage point in order to make up for lost time, undercut criticism of the FOMC for moving “late”, and to provide some stimulus to offset the slowdown in job growth. How necessary is such a move?
It is clear that job growth has slowed since the President initiated large tariff increases on trading partners to press them into restructuring trade relations. He started with very large tariffs to inflict pain and pressure, but his offers to reduce these tariffs in exchange for negotiated concessions further clouded the outlook for business. Companies still do not know the rules of the road going forward, so many paused hiring. Private sector layoffs remain low, but private hiring is limited, while government layoffs offset much of the hiring that is taking pace. Economic growth has slowed as a result, but it remains our judgment that the risk of recession remains low, although not zero. So, it behooves the Fed to step in to lower rates to provide support for growth, even as it is unclear just how much support is actually needed.
Both households and businesses are in a strong position to finance growth in spending. And it is possible that providing more impetus for growth might prove counterproductive in the Fed making progress towards its 2% inflation target. In fact, policy moves in either direction invariably risks overshooting, which is why the Fed prefers to take small steps routinely to better gauge the progress it is making towards its goals.
Nonetheless, the latest jobs data clearly tilts the risk towards justifying rate cuts, even a 50 basis point cut. Investors now expect rate reductions of 0.25% at each of the three remaining FOMC meetings scheduled this year, but the Fed could provide a strong psychological boost by just slightly accelerating that pace. It might have little impact on the economy’s trajectory, but it could greatly mitigate the political criticism that is being heaped on the Fed for a variety of reasons. The economy does not appear to be on the edge of a recession, despite the slowdown in hiring. Corporate profits are rising strongly and household finances are also in excellent shape, so both could easily pick up the pace of spending. But a large rate cut would turn down the heat on the Fed and still leave it with plenty of flexibility to address the economy’s needs without undue concern over the possibility of political intervention.
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