The recent NFP report came short of expectations, with 142k jobs added (expectations were for 164k). However, unemployment did not rise (at 4.2%), and wage growth ticked up to 0.4% — putting more stress on inflationary pressures. In short, this recent report isn’t what markets wanted to see. It shows some weakness, not enough to call for a recession, considering the number of jobs added is above the monthly number needed to maintain the average population growth. At the same time, unemployment is at a point to trigger the Sahm rule. However, higher wage growth lowers the chances for the Fed to cut rates by 50 bp in September. The market expects the Fed to cut rates by 25 bp but still hopes for a 50 bp cut – probably what the US economy may need given the quick weakening of the labor market.
Source: FRED
As I said before, the FOMC is a conservative bunch that tends to react to news slowly and wouldn’t want to act too aggressively – even if it should – in its rate cuts. Instead, the FOMC will likely reiterate its data-driven approach, cut rates by only 25 bp, and signal for additional cuts at every meeting throughout the rest of the year.
Alas, the elections could play a role in the FOMC’s decision in the September and November meetings – even if the FOMC won’t admit it. The prospects of another Trump presidency could result in policies exacerbating inflationary pressures, such as renewing trade wars or reducing corporate and household taxes. Such policies could make the FOMC’s job harder as it tries to stimulate the economy without raising inflation. In contrast, such fiscal policies may provide little stimulus (such as tax cuts) and mainly raise inflation. In such a scenario, the Fed will tread lightly and may revise its prospects of additional rate cuts to avoid higher inflation. The FOMC doesn’t like to course correct abruptly or show possible bias and would probably be more indirect in its plans. This scenario could put the FOMC in a bind and keep the door open on a 50 bp cut in September.
The bond markets place a 25% chance of a 50 bp cut in September, which seems reasonable. Indeed, the most likely scenario is a 25 bp cut. However, assuming the following CPI report doesn’t show any pick-up in inflation, the FOMC might be more inclined to cut rates by 50 bp to avoid a hard decision in November and take a more “wait and see” approach after the September cuts – especially if the FOMC does not want to suddenly revise its outlook after the elections if the outcome leads to reshaping the fiscal policy trajectory.