Prior to Friday’s jobs report for July, traders were banging the table for the Federal Reserve to lower interest rates by a quarter percentage point in September. But that was a day go. Friday is a different story. Now, markets are pushing for the Fed to cut by at least half a point when it next meets, as worries about a slowing economy and even a recession come more clearly into view following nonfarm payrolls growth last month that fell short of even modest expectations . The Bureau of Labor Statistics reported that payrolls rose by just 114,000, compared to the estimate for 185,000, while the unemployment rate climbed to 4.3%, its highest since October 2021. “A 50 basis point Fed cut in September is clearly justified as the labor market is now showing clear signs of softening,” said Yung-Yu Ma, chief investment officer at BMO Wealth Management. “The Fed is already falling behind the curve and rates are overly restrictive — a 50 basis point cut in September would only be catching-up to, rather than getting ahead of, the curve.” Ma’s thoughts were representative of commentary across Wall Street on Friday. Citigroup was the first on the Street to make a half-point cut as part of its official forecast. The firm, which has long been saying the Fed will need to cut aggressively this year, expects another 50 basis point cut in November by a 25 basis point cut move in December. A basis point is 0.01 percentage point. Economists and market strategists speculated that the Fed, rather than provide hints of a reduction in September, perhaps should have just gone ahead and lowered rates by a quarter point at its two-day meeting that concluded Wednesday. “There have already been concerns that the Fed has been late to the party regarding cutting rates, and this report feeds into that narrative,” said David Donabedian, CIO at CIBC Private Wealth. “There is a rising risk of recession unless the Fed works more quickly now.” Recession close? One oft-cited concern is the “Sahm Rule,” which uses increases in the unemployment rate as a recession indicator. The rule states that recessions occur when the three-month unemployment rate average is half a percentage point higher than the 12-month low. In the present case, those respective numbers are 4.1% and 3.5%, indicating that the rule has been triggered. While some economists and Fed officials stress the uniqueness of the present circumstances of the post-Covid economy, there are still concerns that the rule may prove to be correct again. “We have to acknowledge the Sahm Rule does capture an important aspect of the historical data,” said Preston Caldwell, chief U.S. economist at Morningstar. “We do think the market is overreacting to a degree … Nonetheless, it’s time for the Fed to cut the federal-funds rate.” Markets indeed reacted sharply to the jobs news. The S & P 500 lost more than 2.5% and Treasury yields plummeted, sending the policy-sensitive 2-year note down more than a quarter percentage point to 3.91%. Fed funds futures prices surged as well, with traders pricing in a strong chance of a half-point cut in November, along with cuts through the remainder of the year totaling at least a full percentage point. To be sure, the fed funds futures market has been well off the mark through most of 2024 in its anticipation of cuts, as the momentum has shifted back to expectations earlier in the year for aggressive easing. “The Fed is behind the economic curve to the same degree it was behind the inflation curve back in 2021 and 2022, and there will be hell to pay for this policy mis-step — especially given the tense political environment with an election just three months away,” wrote David Rosenberg, the founder of Rosenberg Research. Fed Chair Jerome Powell was asked at his post-meeting news conference why the Fed, if it feels that cuts are on the horizon, didn’t move this week. “The broad sense of the Committee is that we’re getting closer to the point at which it will be appropriate to reduce our policy rate, but that we’re not quite at that point yet,” he said. However, the feeling from the investing community is that the Fed’s words could come back to haunt it. Policymakers will resume making public speeches next week, during which they will have to explain the current stance of policy. “The jobs data are signaling substantial further progress that the Federal Reserve made a policy error by not reducing the Fed Funds rate this week,” said Jamie Cox, managing partner at Harris Financial Group. “It’s very possible the Fed alters its inter-meeting communications on the balance of risks to remove all doubt [of] a September rate cut.”
