The Federal Reserve has been reluctant to commit to an autumn interest-rate cut, citing the dangers of stoking inflation pressures if it moves too early and noting the surprising resilience of the world's biggest economy.
Recent data from the job market, however, and the likely weakness to come over the coming months are expected to cement the case for a September rate reduction and might accelerate bets on further loosening by the end of the year.
Fed Chairman Jerome Powell hinted at this change in focus on July 31 when he told reporters in Washington that the risks to the central bank's mandate were moving into what he called "better balance."
Wall Street took that as a direct reference to the weakening labor market, which the Fed is tasked with supporting alongside its responsibility to keep prices stable.
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Powell said the labor market was "normalizing" after a long period of overheating; the unemployment rate had held at or under 4% for 27 months, the longest streak on record.
Fed stands ready to respond
"We are watching the labor working conditions quite closely, and that's what we're seeing. If we start to see something that looks to be more than that, then we're well positioned to respond," he added.
So far, those conditions haven't been good.
Weekly jobless claims jumped to the highest levels in nearly a year over the period ended July 27, the Labor Department said Thursday, with around 250,000 Americans filing their first paperwork for unemployment benefits.
The running total of continued claims, meanwhile, which lag the headline measure by a week, hit 1.88 million, the highest level since 2021.
Today’s Jobless claims (249k) – highest since late 2023. Rising jobless claims is a classic timely recession indicator and clearly one that’s concerning.
— Longview Economics (@Lvieweconomics) August 1, 2024
PLUS also today – Hershey’s CEO (in earnings press release):
““Today’s operating environment remains dynamic with consumers… pic.twitter.com/y8381UJjoc
Hiring is also slowing sharply, according to a closely tracked report from Challenger Gray. Employers have said they plan to add 3,676 workers in July, taking the year-to-date total to 73,596, the lowest in more than a decade.
Job cuts are also edging higher, with the highest July tally in four years and the third-highest year-to-date total since 2009, Challenger Gray reported.
Rising layoffs and slower hiring
A dig into Thursday's manufacturing PMI survey from the Institute of Supply Management, meanwhile, shows the share of managers expecting hiring to slow is at the highest level in nearly two years.
"Respondents’ companies are continuing to reduce head counts through layoffs, attrition and hiring freezes," the report noted.
"Panelists’ comments in July indicated a notable increase in staff reductions compared to June, supported by the approximately 1-to-1.8 ratio of hiring versus head-count reduction comments," added ISM Chairman Tim Fiore.
Related: Fed drops biggest hint yet on next interest rate move
Economists are still looking for a relatively solid gain of 148,000 new jobs in Friday's July nonfarm-payrolls report, but wage increases are likely to be muted as employers tighten their belts heading into the second half.
Wall Street is expecting average hourly earnings growth to slow to around 3.7%, with monthly wages rising 0.3% and the headline unemployment rate holding at 4.1%.
Wage gains have eased
Earlier this week, payroll-processing group ADP reported a smaller-than-expected total of 122,000 new private-sector hires last month and noted that the pace of wage gains eased to the slowest pace in three years.
“With wage growth abating, the labor market is playing along with the Federal Reserve’s effort to slow inflation,” the group's chief economist, Nela Richardson, said. “If inflation goes back up, it won’t be because of labor.”
A separate report on unit labor costs over the second quarter, which the Fed closely tracks, showed the smallest increase in three years.
Powell hit on this theme in his rate-decision news conference as well, telling reporters that a rate cut "could be on the table as soon as the next meeting in September" if the labor market remains steady and inflation pressures continue to ease.
Related: PCE inflation report cements timing of next Fed interest rate cut
The problem with that assessment, however, is that the Fed might have left rates too high for too long to allow the job market to normalize on its own.
With the Federal Funds rate at a 22-year high of between 5.25% and 5.5% for the 12th month running, companies are suffering from tight credit conditions and cutting back on expansion plans.
Is the Fed behind the curve?
Traders have locked in bets on a September cut, with the odds of a year-end Federal Funds rate of between 4.5% to 4.75% rising to 64%, according to CME Group's FedWatch tool.
Benchmark 10-year Treasury note yields, meanwhile, have fallen below the 4% mark for the first time since February, while rate-sensitive 2-year notes hit a six month low of 4.209%.
First 3-handle since Feb
— Carl Quintanilla (@carlquintanilla) August 1, 2024
@CNBC pic.twitter.com/qDdLLvPlL4
"Because the Fed failed to move yesterday, the ongoing deterioration in the economic data, as evidenced by today’s rising initial jobless claims, low unit labor costs, and abrupt slowing in global manufacturing activity, suggest that we are getting close to a point where bad economic news is bad for markets," economists at Renaissance Macro Research said Thursday.
"Until the Fed begins cutting, they are going to look behind the curve," they added. "The upshot is that this is a small policy mistake that can be undone very quickly."
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That view was echoed by Ian Shepherdson of Pantheon Macroeconomics, who sees both a 0.25-percentage-point rate cut in September and reductions of 0.5 point over the Fed's final two meetings in November and December.
"The Fed has been "too slow in recognizing too slowly that the labor market is cooling and that high inflation is yesterday’s problem," he argued.
"We expect Powell’s speech in Jackson Hole in late August to signal clearly that a rate cut is coming in September, but he probably will wait until October before conceding that policy is well behind the curve," he added.
Related: Veteran fund manager sees world of pain coming for stocks
