The Federal Reserve held its key interest rate steady last week and hinted at the possibility of a rate cut in September.
What happened next seemed straight out of a poorly written movie script. Softer-than-expected economic data began to pour in, as if to admonish Fed officials for not acting sooner to lower the Fed funds rate. The prophets of doom and charlatans of gloom did not waste any time, emerging with claims that the economy, which was growing at 2.5% due mostly to strong consumer spending, was on the brink of a calamitous economic downturn. Fear began to set in. Stocks and treasury yields plummeted as financial market participants became convinced that central bankers had made a grave policy error and that the Fed was once again behind the curve.
The June construction spending data showed another decline, the Institute for Supply Management (ISM) reported that the manufacturing sector remained in contraction territory, and the latest Bureau of Labor Statistics jobs report revealed another sharp increase in the unemployment rate.
The unemployment rate moved up to 4.3% from 4.1% in June. Wage growth moderated to 3.6% year-over-year, down from 3.9%. Employment gains remained concentrated in just a handful of sectors.
The reality is that the labor market is just cooling, expanding at a slower pace but not crashing. Most of the increase in the unemployment rate is due to a large increase in America’s workforce. And that’s a good thing.
As more workers join the labor force, some find work immediately while others end up unemployed, essentially just looking for work. As a result, total employment and the total number of unemployed workers rise. Since hiring rates have also moderated from the torrid pandemic pace, the increase in unemployment has outpaced employment gains, thus raising the unemployment rate. Layoffs remain low, and the labor market hasn’t cracked yet. Instead, employment may simply be reaching a ceiling, as Ernie Tedeschi, the director of Economics at The Budget Lab at Yale, so eloquently put it.
While hiring has slowed, this labor market started cooling from a very strong position. The last time the employment rate of America’s prime working-age population was this high was in April 2001. In other words, if you are between the ages of 25 and 54, you are more likely to be employed today than at any time in the past 23 years.
With inflation moderating fast, the Fed has garnered enough evidence that the time for a less restrictive policy rate has come. The shift to a more neutral policy stance will help support aggregate demand and keep the U.S. economy growing at a more sustainable pace.
Shortly after the jobs report, traders began to price in a 50-bps rate cut at the Fed’s September meeting. But by the end of the trading day, expectations had shifted back to just a 25-bps rate cut in September. Despite higher volatility last week, market participants still expect three 25-bps rate cuts this year, beginning in September.
The 10-year treasury yield – that mortgage rates tend to follow – is now at its lowest level since December 2023. Don’t be surprised to see yields move back up in the weeks ahead.
