As the Federal Reserve gears up to initiate its first interest rate cuts in months, the key question now revolves around the magnitude of the reduction. The answer may hinge on the upcoming US employment data, due this Friday, which has investors on high alert.
The July jobs report, released last month, showed an unexpected rise in the unemployment rate, triggering a well-known recession indicator and sparking concerns that the economy could be teetering on the edge of a downturn. In the wake of this report, financial markets reacted with caution, but stocks have since rebounded. Forecasters now anticipate that the August report will show a rebound in hiring and a slight decrease in unemployment, after four consecutive months of increases.
Federal Reserve Chair Jerome Powell emphasized in his speech on August 23 that the central bank is now more focused on potential risks to the labor market than on inflation. This shift in focus means that if the upcoming jobs report shows further weakness, it could strengthen the case for a more substantial rate cut.
“The jobs report has always been a crucial monthly economic indicator in the US, but its importance is especially heightened now,” said Sal Guatieri, senior economist at BMO Capital Markets. “Not just the next jobs report, but future reports will play a significant role in shaping the Fed’s policy decisions.”
This change in the Fed’s priorities has led financial markets to place greater emphasis on employment data over inflation figures. As a Morgan Stanley strategist recently observed, “It’s all about the labor data now.”
This marks a return to pre-COVID patterns when employment data was the primary concern, with inflation considered secondary. During the pandemic-driven inflation surge, the focus shifted to indicators like the Consumer Price Index (CPI). However, the recent moderation of inflation has brought the labor market back into the spotlight for investors.
In the bond market, for example, two-year Treasury yields—those most sensitive to Fed policy—have reacted nearly three times more to employment data than to CPI releases over the past three months. The July employment report, which triggered the “Sahm Rule” recession indicator, was a significant factor in a $6.4 trillion global market selloff.
“If more weight is placed on each payroll report, we could see a return to an extremely volatile market environment,” said Gregory Daco, chief economist at EY. “Unfortunately, many economists and Wall Street investors tend to react emotionally to such data.”
Political Implications on the Campaign Trail
The focus on jobs isn’t just a concern for Wall Street; it’s also gaining traction on the campaign trail. Recent consumer sentiment data showed that Americans are increasingly pessimistic about the labor market, with a growing number of people reporting that jobs are becoming harder to find.
Ashley Turner, a 32-year-old from Houston, is one such individual. After being laid off from her marketing job a year ago, she has applied for nearly 200 positions, landing only eight interviews. Despite expanding her search to other fields, Turner is considering taking on contract work or even starting her own business. For her, the job market is a more pressing issue than inflation, and it’s also a key concern as the presidential election approaches.
Former President Donald Trump, the Republican nominee, has tried to blame Vice President Kamala Harris, his Democratic opponent, for the labor market’s recent struggles, as she is a prominent member of the Biden administration.
Meanwhile, Harris has focused her messaging on addressing inflation and supporting the middle class. In a recent CNN interview, she stated that her top priority would be to alleviate economic pressures, though she provided few specific details on her plans.
“High inflation affects everyone, but unemployment is a worry even for those who still have jobs,” said Veronica Clark, an economist at Citigroup Inc. “The fear of job loss can make the situation feel even more precarious.”
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