Last week’s weak July jobs report generated a seismic shift in expectations for Federal Reserve interest-rate cuts.
Going into the Aug. 2 news, most experts anticipated a 25-basis-point rate cut at the Fed’s September meeting and possibly another 25-basis-point move at the November or December meeting.
But the employment numbers included an increase of only 114,000 in non-farm payrolls during July, compared to analysts’ forecast of a 175,000 gain. And the unemployment rate rose to 4.3%, the highest level since October 2021.
Olivier Douliery/Bloomberg via Getty Images
The numbers sparked concern about the economy’s health among investors and economists. They ratcheted up their forecasts for Fed rate reductions.
Interest-rate futures signal a 69% chance that the Fed will cut rates by 50 basis points at its next meeting in September, according to CME FedWatch.
And the futures show an 84% probability that rates will be slashed by at least 100 basis points combined before year-end. The Fed’s standard rate change is generally 25 basis points per meeting.
The central bank’s federal funds rate target has stood at 5.25%-5.5% since the Fed ended its last rate-hike cycle in July 2023. The fed funds rate is what banks charge each other for overnight loans. Banks borrow from each other to maintain capital stability.
JPMorgan, Citigroup Fed rate projections
Shortly after the jobs report, JPMorgan Chase and Citigroup economists issued extremely dovish Fed-rate projections for the rest of the year.
They foresee 125 basis points of Fed rate reductions by year-end: 50 points in September, 50 in November, and 25 in December.
JPMorgan economist Michael Feroli even said there’s “a strong case to act” before the Sept. 18 meeting. But Fed Chair Jerome Powell might not “want to add more noise to what has already been an event-filled summer,” Feroli wrote in a commentary cited by Bloomberg.
Related: Goldman Sachs revamps interest rate forecast as stocks slump
The Fed generally doesn’t shift policy between meetings unless an emergency hits the economy and financial markets.
Still, “even if the softening in labor market conditions moderates from here going forward, it would seem the Fed is at least 100 basis points offsides, probably more,” Feroli said.
But before we get too excited, it’s worth noting that the jobs statistics weren’t all that weak.
Temporary factors may have depressed payrolls, and the jobless rate is historically low.
Also, while average hourly earnings rose less in July than June, they were still up 3.6% from a year earlier.
Morgan Stanley’s view on the economy, Fed
Lisa Shalett, chief investment officer of Morgan Stanley Wealth Management, has a nuanced view of the economy and Fed policy.
A soft landing, meaning lower inflation without a recession, “remains our base case,” she wrote in a commentary. But, “we recognize that the path to a ‘Goldilocks’ scenario is narrowing, with U.S. consumers increasingly solely dependent on jobs for consumption.”
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There are plenty of headwinds, Shalett said. “Corporate management teams face aggressive margin expansion expectations, while global growth is slowing and pricing power is fading.” That’s happening amid growing uncertainty for tariff, tax, and regulatory policy, she noted.
Shalett said the equation is tricky for the Fed, given its high government debt levels, lofty balance sheet, and money supply growth. The federal government’s debt totals $35 trillion, and the Fed has $7.2 trillion of assets.
Slow and shallow interest rate cuts
“True soft landings are bumpy and trendless, and the Fed will likely proceed slowly and deliver only shallow accommodation,” she said. That means likely reductions in the fed funds rate to about 3.5% by early 2026, she said.
Falling rates lower the income for your bonds, bank accounts, and money-market funds. But they also lower payments for your mortgage, auto, and credit-card loans.
Related: Mortgage rates get huge boost from Fed signals, bond market rally
And what does Shalett’s forecast mean for your investing? “In this scenario, we believe the best tactical advice is to focus on asset-class diversification and valuation and growth at a reasonable price among equities,” she said.
“Favor the equal-weighted S&P 500 or active stock picking in high-quality cyclicals or defensives while avoiding the temptation to chase small-cap momentum or the Magnificent Seven bounce.”
The regular S&P 500 index weighs stocks by their market capitalization. The Magnificent Seven includes Alphabet, Amazon, Apple, Meta Platforms, Microsoft, Nvidia, and Tesla.
Related: Veteran fund manager sees world of pain coming for stocks
