For monetary policymakers, the current situation facing the US economy is, in the words of Jerome Powell, ‘challenging’. While there is clearly some inflationary pressure building, the jobs market is showing signs of weakening. That is a tricky divergence for the Federal Reserve to handle with the two sides of the dual mandate – price stability and a healthy jobs market – pointing in different directions.
Markets, correctly, read Chairman Powell’s Jackson Hole address as focusing the central bank more on the weakness in the labor market than on tariff-induced price pressures. The Chairman argued that a ‘reasonable base case’ scenario is that tariffs represent a ‘one-time’ rise in the price level rather than the beginning of an ongoing inflation problem. Indeed, the weakness of the jobs market means that workers are unlikely to be able to respond to that rise in prices by bargaining their own wages up to protect their incomes. That may not be great news for workers, but it does at least suggest that so-called second-round effects could be minimal.
Meanwhile, with policy rates around 100 basis points – or one percentage point – above neutral, the Fed has the policy space to lower rates in response to the slowing jobs market.
Against expectations of a net 75,000 new jobs in August, the Bureau of Labor Statistics reported just 22,000. The revisions to previous months were equally noteworthy. While the July total was nudged up to 79,000, June’s figure was notched down to -13,000 – the first monthly fall in payrolls since the pandemic of 2020.
Of course, one needs to exercise some care with the data. The ever-present possibility of later revisions means that focusing on any individual month’s release is somewhat foolhardy. But the longer-term trend at least appears clear. The pace of job creation slowed sharply over the last six months. Over the last twelve months, net monthly payroll growth averaged around 122,000, but over the last six months, that fell to around 64,000, and over the most recent three months, the monthly average dropped further to just 29,000 per month.
The sectoral breakdown is also useful. Manufacturing jobs have been falling for four months, while those in the wholesale trade have fallen for three consecutive months. Both sectors are highly exposed to the disruptive impact of tariffs on trade.
Markets took the news as confirmation that rate cuts are coming. Some prominent investors have even begun to speculate that a jumbo 50 basis point cut, rather than a more traditional 25 basis point reduction, could be in play for September. Either way, around 75 basis points of cuts are now expected by the end of the year.
Stocks fell, with the S&P 500 finishing the day down 0.3% on Friday. That is, by recent standards, somewhat unusual. In general, equity markets have been in one of their ‘bad news is good’ phases recently with the assumption being that as bad news on the labor market will likely lead to lower interest rates, the net impact on equity markets will ultimately be positive. This time around, though, it would appear, at least initially, that equity investors are more concerned with a deteriorating immediate outlook than with whether lower rates will boost asset prices in the medium term.
According to S&P Global Intelligence, who compile the data, the most recent numbers suggest that growth has accelerated to an annualised rate of around 2.5% in the third quarter, up from 1.5% in the first half of the year. If growth is indeed picking up – alongside inflation – then the case for large-scale rate cuts appears much weaker.
Dealing with contradictory signals is part and parcel of economic policymaking, and such divergences between so-called hard data – collected by statistical agencies – and soft data from surveys are not unusual.
Perhaps the best bet is to expect a rate cut in September but to keep a more open mind about what happens between October and December. That is certainly what the Fed, which forever insists it remains data-dependent, argues it will do.
The current outlook is a useful reminder that setting monetary policy is far from straightforward. Policymakers are struggling to weigh up the evidence as to the current state of the United States economy, let alone its future path, and what that means for the dual mandate.
Against this backdrop, the attacks on the Fed’s independence become even more concerning, a topic to which On Global Markets will be returning in the near future.
