Unemployment Uptick May Pressure Fed to Cut Interest Rates Aggressively: Jobs Report

In the wake of Friday’s jobs report showing the labor market deteriorating unexpectedly sharply, the question on the minds of investors and economists is no longer whether the Federal Reserve will cut interest rates at its next meeting in September, but how steeply it will cut them.

Key Takeaways

• A sudden and surprising jump in unemployment in July could inspire the Federal Reserve to cut interest rates more steeply than previously anticipated.
• The Fed may cut interest rates to boost the economy and prevent mass layoffs, shifting its attention away from fighting inflation as price pressures have moderated.
• Some economists cautioned that Friday’s unemployment data could be a fluke driven by temporary factors such as Hurricane Beryl keeping people from working early in the month.

The jump in the unemployment rate in July to its highest since 2021 could give the Fed motivation to cut its benchmark fed funds rate faster than previously expected. Several forecasters changed their predictions for the central bank’s next moves, calling for three quarter-point rate cuts by the end of the year instead of two.

Traders are projecting an even more aggressive path. Financial markets late Friday were pricing in 1.25 percentage points of rate cuts by the end of 2024, up from three-quarters of a point the day before, according to the CME Group’s FedWatch tool, which forecasts interest rate movements based on fed funds futures trading data. The likelihood being priced in of a half-point cut at the September Fed meeting was around 72%, up from 22% on Thursday.

The Fed is now under pressure to respond to the weakening labor market because of its twofold mission to keep inflation low and employment high. Recent reports have shown inflation falling towards the Fed’s goal of a 2% annual rate from its post-pandemic surge, and with the threat of rising unemployment growing larger, the central bank may shift its focus towards preventing mass layoffs.

“This clearly gives the Fed the green light to start cutting rates in September, and the market’s attention will now shift focus toward how many and how deep the coming cuts will be,” Scott Anderson, chief U.S. economist at BMO Capital Markets, wrote in a commentary.

Fed Has Said Rates Could be Cut in September

Earlier this week, the Fed’s policy committee opted to leave its influential fed funds rate at a range of 5.25% to 5.50%, where it has been for a year. Fed Chair Jerome Powell said that the central bank could cut the rate as soon as the Federal Open Market Committee’s next meeting in September.

The shift to possible rate cuts marks a turning point for the Fed, which raised interest rates starting in March 2022 to combat inflation. By lifting the fed funds rate to their current level, the highest since 2001, the Fed put upward pressure on interest rates for mortgages, credit cards, and other debt, discouraging borrowing and spending in an effort to cool off an overheated economy and allow supply and demand to rebalance.

Further economic data is due to be published before the Fed has to make a decision on interest rate moves in September, including several reports on inflation and another major report on the job market, which could shift the outlook.

Could the July Jobs Data Represent a Blip?

There’s also a chance that the jump in unemployment may prove to be a temporary blip rather than the start of a trend. As Matt Coylar, an economist at Moody’s Analytics noted, many of the unemployed in July simply couldn’t work because of bad weather caused by Hurricane Beryl.

“I think this is just too narrow of data just yet to really inspire panic,” Coylar said in an interview with Investopedia. “And I would say that financial markets are potentially overreacting.”

However, even if the job slowdown isn’t as bad as it seems at first glance, the psychological impact could make it a self-fulfilling prophecy, especially if future data reinforces the impression, Coylar said.

Markets Already Pricing in Lower Rates

At least for now, fed-watchers are betting that the days of high interest rates are numbered.

Just as the rate hikes pushed borrowing costs to their highest in decades, a lower fed funds rate is meant to ease some of that financial pressure, and could lead to lower borrowing costs for many kinds of loans.

For example, rate cuts could offer some relief to homebuyers who have been priced out of the market by high mortgage rates. The expectation of rate cuts, in and of itself, also helps push mortgage rates down.

“The market is moving ahead of the Fed, bringing down longer-term rates including those for mortgages, which should lead to both more home purchases and a pickup in refinance activity,” Mike Fratantoni, chief economist at the Mortgage Bankers Association, wrote in a commentary.

The yield on 10-year Treasurys, which is closely tied to mortgages, fell to around 3.80% Friday, the lowest level since last December.

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