The U.S. central bank may be rethinking its decision to keep borrowing costs unchanged earlier this week after a government report on Friday showed the job market slowed sharply last month.
The Labor Department reported that payrolls rose by just 114,000 in July, sending the unemployment rate up to 4.3%, signaling an unexpected deterioration in a labor market that had held up surprisingly well during the Fed’s aggressive interest-rate hikes.
As the central bank decided on Wednesday to keep interest rates unchanged at their current range of 5.25% to 5.5%, Fed Chairman Jerome Powell said the labor market was in a process of “continuous and gradual normalization” and the Fed could wait a little longer to ensure inflation is subdued before cutting rates.
“If Chairman Powell knew then what he knows now, he probably would have cut rates,” said Brian Jacobsen, chief economist at Annex Wealth Management. “By keeping rates unchanged as inflation was falling, the Fed put too much pressure on the brakes. The Fed realized too late how quickly things were changing and therefore can’t rely on economic momentum to bail it out.”
Data traders are betting that the Fed will cut rates by half a percentage point at its Sept. 17-18 meeting and continue to cut rates thereafter, leading to rates being more than a percentage point lower than current levels by the end of 2024.
“We don’t want to see a further significant slowdown in the labor market,” Powell told reporters on Wednesday. “If we see signs of a more severe downturn, we will respond to that.”
Before the report, interest rate futures were pricing in a 0.25 percentage point cut starting in September.
“The Fed’s inaction this week was a mistake and the case for a 50 basis point rate hike in September is strong,” Ian Shepherdson, chief economist at Pantheon Macroeconomics, wrote in the note.
As analysts scrutinized the report, some were left with the impression that the underlying data was less weak than the headline numbers: Labor force growth was strong, with the labor force participation rate rising from 62.6% to 62.7%.
The Bureau of Labor Statistics said Hurricane Beryl had no impact on its data, but “we remain somewhat skeptical,” wrote Thomas Simons, senior economist at Jefferies. The number of people reporting they were unable to work because of the weather reached a record high of 436,000.
Analysts said that, combined with the fact that fewer businesses than usual responded to the monthly employment survey, raised the possibility that some of the weakness would be corrected in upcoming reports.
The 0.2 percentage point increase in the unemployment rate triggered the so-called thumb rule, a historically accurate early indicator of economic downturn.
Claudia Thaam has warned about taking too much signal from his rule given the labor market turmoil caused by the pandemic, and Powell said this week that it was a “statistical regularity” and did not mean a recession was “certainly going to happen.”
Still, the report raised concerns that the Fed may have waited too long to cut interest rates.
In June, central bank policymakers in their quarterly forecasts predicted just one interest rate cut this year and projected the unemployment rate to be 4% by the end of the year.
With unemployment now well above that, “the soft landing for the U.S. labor market is at risk,” Indeed economist Nick Bunker wrote.
