Fed May Cut Rates 50 Basis Points If Labor Market Deteriorates

There is a growing risk that the Federal Reserve will need to cut interest rates by 50 basis points in December to address a weakening labor market, according to Oxford Economics. The June jobs report, while showing strong headline numbers, revealed underlying data that indicated a slowing labor market. If the labor market were to deteriorate unexpectedly, the Fed would be compelled to implement such a significant rate cut.

Interest rate cuts serve as a crystal ball, revealing either good economic fortune or the onset of a downturn. On one hand, interest rate cuts could signal that the Federal Reserve has deemed the economy stable enough after the tariff-induced uncertainty. This outcome would be welcomed by investors and President Donald Trump. However, until the uncertainty subsides, interest rates will remain unchanged.

There is a scenario where rate cuts are not a sign of relief but the start of a long-feared downturn. If the labor market suddenly starts to decline, the Fed would have to intervene and cut rates. In this case, investors and the president would face an interest rate cut of 50 basis points, double the usual 25 basis points. Such a rate cut would only occur if unemployment spiked later in the year. The Fed began its holding pattern, largely concerned that Trump’s tariffs would reignite inflation. However, in recent weeks, there has been a greater focus on unemployment—the other side of its dual mandate. Investors are also worried that the labor market may be teetering.

“We think the risk is growing that the first cut is 50 basis points,” said Nancy Vanden Houten, lead U.S. economist at Oxford Economics. Oxford Economics still forecasts a single rate cut of 25 basis points in December. However, the fact that the firm is considering a jumbo rate cut indicates genuine fears that the labor market could deteriorate quickly and dramatically. The nature of the labor market slump is more critical than anything else.

If the labor market decline is “unexpected in a shock kind of way, that would motivate a 50-basis-point reduction at the end of the year,” said Jose Torres, senior economist at Interactive Brokers. “You would need things to go bad really quickly towards the end of the year for that to happen.” If the bad news is swift and severe, the Fed will have to act quickly.

“We do see a growing risk that the first move is larger, i.e. 50 basis points, because we think the Fed at that point may have some catching up to do” with the labor market, Vanden Houten said. The current labor market is remarkably stable despite the market turbulence that surrounded the original tariff announcements. However, there are subtle changes indicating it is loosening. In June, the unemployment rate ticked down to 4.1% from 4.2%. That headline number, which came alongside 147,000 new jobs, belied slowing momentum in the job market. Private sector jobs grew at the lowest level in eight months; 130,000 people dropped out of the labor force; and individuals out of a job were staying unemployed for longer.

These nuances do not point to a labor market in imminent danger but one that is shifting beneath the economy’s feet. “The numbers aren’t horrible, allowing the Fed to focus more on inflation right now. And as I noted, the latest data allow the Fed to breathe a little easier, although there were definitely some quirks in the June employment data that probably made the labor market look a little better than it is,” Vanden Houten said. Economic growth would have to significantly underperform expectations and hiring levels would need to be below 50,000 a month in October and November for the economic picture to worsen quickly enough to force a 50 basis point cut, according to Torres. The possibilities of both happening are unlikely at the moment. Investors expect growth and the labor market to slow later in the year, but not to those levels. Some have revisited those projections as Trump’s looming tariff deadline approaches.