Non-farm regains market dominance, will the door be knocked on for a 50 basis point rate cut in September?

For the financial markets, the key issue surrounding the prospect of the Fed's loose monetary policy is increasingly focused on the size of the rate cut, rather than the timing.

The expectation that the Fed will start cutting rates in September has been a steady bet for several weeks. Fed Chairman Powell stated without hesitation at the press conference after this week's policy meeting that as long as the economic data between now and the next meeting moves in that direction, there is a possibility of a rate cut at the next meeting.

The first important data will be released on Friday, when the Fed will gain new insights into its dual mandate of maximizing employment, which it has been focusing on suppressing inflation. According to a Reuters survey of economists, the U.S. Labor Department's monthly employment report is expected to show an addition of 175,000 jobs in July, with the unemployment rate remaining at 4.1%.

If the data meets expectations, the report will indicate that the labor market remains strong but slightly cooling, further proving Powell's point that "employment data broadly show that the labor market conditions are gradually normalizing."

Powell stated that if this trend continues, the Fed "may discuss" a rate cut at the meeting on September 17-18. His wording suggests that the rate cut will not exceed the Fed's usual 25 basis points.

"However, weaker readings, including fewer new jobs or an increase in the unemployment rate, may support the case for a larger rate cut, whether in September or at future meetings."

Powell told reporters, "I don't want to see further cooling in the labor market. If we see a more serious recession-like situation, we will respond to it."

When asked if the Fed would start with a larger rate cut than usual, Powell said, "That's not something we're considering right now."

But the financial markets are clearly already considering this. Interest rate futures suggest that there is about a 25% chance that the Fed will cut the benchmark overnight rate by 50 basis points from the current range of 5.25%-5.50% in September, with the current rate range being maintained for over a year.

Before Powell's speech this week, a 50 basis point rate cut next month was seen as an unlikely scenario, with a probability of only 5%. However, Thursday's data also intensified the bet that the Fed needs to take a proactive response. Data showed that the factory employment level index fell to a four-year low last month, and new applicants for unemployment benefits rose to the highest level in nearly a year.

The financial markets also expect that by the end of this year, there is a one-third chance that the Fed will lower the policy rate to the range of 4.25%-4.50%. To reach this level, at least one of the remaining three policy meetings in 2024 would need to have a rate cut of at least 50 basis points.

Analysts at Pantheon Macroeconomics expect the U.S. to add 130,000 new jobs last month, below the current market consensus. They believe that even a full percentage point rate cut this year may not be enough to keep the economy stable. They expect the Fed to first cut rates by 25 basis points, then raise them by 50 basis points on November 7-8 and December 6 They wrote this week: "Our view remains that the perception of the Federal Reserve being too late in recognizing the cooling labor market and the end of high inflation. With interest rates far above the neutral level, if, as we expect, labor market data continues to weaken and inflation remains moderate, the easing cycle may be much faster than the market expects."

The view of Pantheon Macroeconomics is not widely accepted. Most economists expect the Federal Reserve to gradually cut interest rates, with each cut being 25 basis points, and many still believe that there will only be two rate cuts this year. Policymakers in the June quarterly forecast only expected one rate cut this year.

However, since that quarterly forecast was released, inflation data has declined, and the future direction of Federal Reserve policy increasingly depends on the development of the labor market.

Economists at Deutsche Bank wrote in a memo that Powell's speech this week showed that "the upside risks to inflation are no longer the Fed's sole focus in determining when and at what pace to cut rates, and not even the most prominent focus."