Fed "Megaphone": If non-farm payrolls disappoint again tonight, a significant rate cut will be imminent

"The Fed's Megaphone" Nick Timiraos published an article stating that the employment report tonight will affect the Fed's rate cut magnitude as the August non-farm data is about to be released. If the August non-farm report is once again poor, it may lead to a significant 50 basis point rate cut by the Fed, but if the employment situation is good, it will keep the Fed on track for a 25 basis point rate cut. Here is more content from the article.

The August employment report scheduled for release on Friday will play a larger role than usual in determining the magnitude of the rate cut later this month. Fed officials have hinted in recent weeks that a rate cut at the mid-September meeting is almost certain. Officials are satisfied with the slowdown in inflation recovery, and an unexpected setback earlier this year delayed their rate cut plans. However, some are now more concerned about maintaining rates at their highest level in 20 years, as the labor market may have slowed too much. Therefore, the focus of the debate at the Fed's meeting on September 17th to 18th is whether to start with a more traditional 25 basis point rate cut or a larger 50 basis point cut to prevent unwanted weakness in the job market.

The August hiring and employment report released on Friday will be crucial in making this decision. A decent employment report may prompt officials to start a possible series of rate cuts with a 25 basis point cut. If hiring is weak or the unemployment rate rises, as it did in July, a larger rate cut is imminent.

Friday also happens to be the last day before Fed officials can publicly communicate before the self-imposed pre-meeting blackout period begins. New York Fed President Williams and Fed Governor Brainard are scheduled to speak after the employment report is released, providing the final opportunity to set expectations for the upcoming meeting.

The tactical considerations for the Fed's next meeting put officials in a precarious position. With the economy and inflation slowing down as expected earlier this year, it is more reasonable to lower rates from the current level of around 5.3% to close to 4.5%. In fact, economists and investors expect the Fed to cut rates in the upcoming meetings. However, the magnitude of the first rate cut will be closely watched as it reflects economic prospects and risks. The reasons for officials to decide on a 25 basis point cut or a 50 basis point cut will be very important.

If there are no signs that the weakness in July's employment will continue into August, some Fed officials may resist a 50 basis point rate cut. However, at the Fed's most recent meeting at the end of July, some officials with an open attitude towards rate cuts may support a 50 basis point cut in September if Friday's non-farm report shows another jump in the unemployment rate and further slowdown in job growth, they will receive broader support.

When Fed officials last met in July, the employment data showed an unemployment rate of 4.1%. However, a month earlier, the reading was 4.3%, continuing to rise from the low of 3.4% in April 2023. As the recent rise in the unemployment rate is driven to some extent by temporary rather than permanent layoffs, some officials have pointed out reasons to believe that the unemployment rate may decrease in August San Francisco Fed President Daly said in an interview with The Wall Street Journal on Tuesday that the July report "is not a sign of economic weakness." She said, "If these temporary factors disappear, then I think we are still in a healthy state." At the same time, officials do not want to wait for weakness to appear before taking action, as it may be more difficult to prevent a more severe economic slowdown by then.

"If you are at an economic inflection point, by the time you get the published data, it's already too late. So you can't rely solely on this published data because it looks backward." Federal Reserve Chairman Powell said at a press conference on July 31 that cutting rates by 50 basis points "is not something we are considering now." But this was said before the July employment report released two days later, which then raised concerns about a greater cooling in the labor market. A series of employment surveys show that despite stable economic activity, the current tightness in the labor market is not as severe as in 2018 and 2019 before the pandemic.

In a highly anticipated speech two weeks ago, Powell made a more explicit turn and stated that his focus now is on preventing further slowing in the job market. He said the recent cooling is "undoubtedly" and further weakness is "unwelcome." Many interpreted these remarks as keeping all options open for the Fed's next meeting. In recent days, other Fed officials have also expressed similar views. Daly said, "Any further slowdown is unwelcome, and we don't want to wait until we see it because by then it will be too late."

The Fed is a consensus-driven institution, and when economic prospects are uncertain, it tends to take gradual action. Therefore, the Fed often prefers to raise or lower rates by 25 basis points. The last time the Fed switched from raising rates to cutting rates was in 2019, when it first cut rates by 25 basis points. It also did the same during the growth scares in 1995 and 1998.

"I like the mindset of 'test and learn'," Richmond Fed President Barkin said in an interview last month. "Doing and learning at the same time is a better way."

A larger rate cut of 50 basis points usually occurs in emergency situations, such as during the outbreak of the COVID-19 pandemic in March 2020, the credit market dysfunction starting in September 2007, and the significant cooling of manufacturing activity and the labor market in early 2001.

Chief Economist at KPMG Diane Swonk said, "There are very strong reasons to support a 50 basis point rate cut. The labor market is not in recession, but it is on thin ice. Even if the data on Friday is good, the weakness in the labor market is worsening."