Our call has been that there will be one more rate cut this year and that it would more likely come in December than in October. This week’s data and market moves have led us to adjust our call: We now expect an October rate cut, and we also now see a higher probability—though below 50%—that a cut in December will follow the October rate cut.
Frankly, we had discussed this change in our call yesterday afternoon, but we decided to wait until we saw the employment report. The 136K increase in payrolls in September was below the consensus, but that slight miss was made up for by upward revisions to the previous two months. In addition, there was an unexpected two-tenths decline in the unemployment rate. Those were two of the strong points of what was certainly a solid report overall, but there was also notable weakness in wages. The market-implied probability of an October cut declined somewhat after the jobs report, from near 90% to close to 75%. Like the market, after seeing this report, we still expect an October cut.
Now a brief recap of developments this week. At the start of this week, the market was pricing pretty close to even odds of an October rate cut, which seemed reasonable to us. There were some disappointing U.S. and foreign economic data releases this week, many of them relating to manufacturing and investment, and the market-implied probability of an October rate cut rose. After yesterday’s disappointing data—the ISM nonmanufacturing survey and factory goods report for September—the market was pricing in a roughly 90% probability of a rate cut in October. That came down to about 75% after this morning’s jobs report. In addition to the most recent developments this week, a couple of other factors are worth noting. Consumer surveys have pointed to a recent dip in sentiment, and consumer spending disappointed in August. The upward trend in the dollar has also caught the attention of policymakers—although since the last meeting it’s up only modestly.
This morning’s jobs report for September confirmed that the labor market remains strong. Nonfarm payrolls increased 136K in September, a bit below the consensus, but upward revisions to previous months’ gains totaled 45K. The three- and six-month average gains are little changed at 157K and 154K, respectively—very solid. A strong employment gain in the household survey data led the unemployment rate to decline two-tenths, to 3.5%, despite the participation rate remaining at 63.2%. The broader U-6 rate also declined—by three tenths. Since the start of this year, when the participation rate was about where it is now, job gains have lowered the unemployment rate by several tenths.
But a key point is that overheating remains a remote risk. Last week, Clarida repeated a point he’s made many times: “I myself believe that the range of plausible estimates of u* extends to 4 percent and below and includes the current unemployment rate of 3.7 percent.” We suspect Clarida would still be quite comfortable with that statement even after updating it to reflect the new, lower level of the unemployment rate, 3.5%. A low unemployment rate is only a concern for the FOMC to the extent it results in excessively high expected inflation. But rather than suggest the labor market is heating up, the wage data in the September jobs report were soft. Average hourly earnings edged down slightly in September (no change when rounding to one-tenth), and the 12-month change declined from 3.2% to 2.9%. We don’t want to make too much of this month’s print; the point is the wage data have been pretty tame for much of this year, with the six-month annualized change at 2.8%.
The recent data have been more troubling, but they haven’t led us to substantially revise our view on second-half GDP growth, and this jobs report seems to support that. Indeed, it’s hard to argue with the “we are in a good place” mantra, though the data do suggest the economy has slowed to a near trend in the second half, as we have expected. Even after recent declines, U.S. equity prices remain quite high, and financial conditions more generally are accommodative. But it had been a close call between October and December for the next rate cut, and recent data are enough to push our call for the next rate cut to October. The data aside, the FOMC would not disappoint at their next meeting by holding rates steady if markets remain convinced that a cut is in store.
Clarida’s remarks last night—where he again paired a fundamentally optimistic message about the domestic outlook with an emphasis on the FOMC’s willingness to adjust policy on a meeting-by-meeting basis—didn’t budge the market. This jobs report reduced the market’s conviction in October cut somewhat, and strong data releases over the next few weeks—e.g. September retail sales—could reduce it further. But if there isn’t a consensus among policymakers for a cut as we approach the October meeting, it may take some more pointed pushback from key Fed policymakers to prepare the market.