Top Analyst: Potential for a 50 Bps Cut in September Gains Traction off JOLTS Print
3min read The prospect of a 50 basis point (bps) interest rate cut by the Federal Reserve in September is gaining attention among market participants, driven by recent economic data that points to a weakening labor market.
As the non-farm payrolls report looms this Friday and the Federal Open Market Committee (FOMC) enters its blackout period shortly thereafter, the market dynamics are creating a speculative environment ripe with potential volatility.
Citi's Take on the Labor Market and the Case for a Rate Cut
Citi's recent analysis highlights a significant shift in the labor market, which is notably looser than it was pre-pandemic and continues to weaken.
The July Job Openings and Labor Turnover Survey (JOLTS) report underscores this trend, showing job openings falling from 8.184 million in June (revised down from earlier estimates) to 7.673 million in July, which was below consensus expectations. This represents the lowest level of job openings since February 2021 and suggests a labor market cooling at a faster-than-anticipated pace.
One critical indicator that Citi points to is the ratio of job openings to unemployed individuals. The current ratio stands at 1.1-to-1, which is below the pre-pandemic ratio of 1.2-to-1. This decrease suggests that the demand for labor is not as robust as it once was, and that employers may be pulling back on hiring in response to economic uncertainties.
Despite a slight increase in the hiring rate to 3.5% from 3.3%, the overall hiring environment remains subdued, with government hiring showing signs of a slowdown.
Meanwhile, the layoff rate remains low at 1.2%, which indicates that while layoffs have not spiked, hiring freezes and a slowdown in new job openings could be a precursor to further labor market softening.
Given these conditions, Citi argues that a 50 basis point rate cut by the Fed in September is not only likely but necessary to prevent a sharper economic slowdown.
The financial institution posits that with inflationary pressures easing and the labor market showing signs of an inflection point, the Fed might opt for a more aggressive rate cut to stabilize economic conditions. Citi's outlook is shared by some in the market, with the current pricing suggesting a 43% chance of a 50 bps cut.
Market Dynamics and the Fed's Communication Strategy
A unique aspect of the current market environment is the timing of key economic data releases relative to the Fed's communication constraints. The non-farm payrolls report scheduled for Friday is critical, as it will be the last major piece of labor market data before the FOMC enters its blackout period, starting at midnight on Friday.
If the jobs report is middling, it may not provide a definitive signal for a 50 bps rate cut, leaving Fed officials with limited time to guide market expectations through traditional channels.
In such a scenario, the Fed may resort to more unconventional methods to telegraph its intentions, such as strategically leaking information to reliable news sources like the Wall Street Journal (WSJ). This has been a method used in the past to manage market expectations without making formal statements.
The WSJ's Nick Timiraos, often regarded as a "Fed whisperer," has already referenced similar data points, adding to the speculation that the Fed might be considering a more substantial rate cut.
Implications for Investors and the Broader Economy
The potential for a 50 basis point cut in September presents a mixed bag for investors. On one hand, a significant rate cut could provide a boost to equity markets, particularly in sectors sensitive to interest rates, such as real estate and consumer discretionary.
On the other hand, such a move could also be interpreted as an acknowledgment by the Fed that the economic outlook is deteriorating more rapidly than previously anticipated, which could lead to increased market volatility.
Additionally, if the labor market continues to weaken as Citi suggests, the Fed could face growing pressure to adopt a more dovish stance for the remainder of 2024 and into 2025. This could further influence bond markets, where the yield curve remains inverted, signaling concerns about a potential recession.
Conclusion
Citi's analysis, coupled with market data, points to a growing likelihood of a 50 basis point rate cut by the Federal Reserve in September. While the labor market is not yet in a state of crisis, the recent JOLTS report and other indicators suggest a softening that could prompt the Fed to act decisively.
As the market awaits the non-farm payrolls data and the subsequent FOMC blackout period, the next few days will be critical in determining whether the Fed will take a more aggressive approach to rate cuts.
Investors should remain vigilant and prepare for potential volatility as the Fed's decision-making process unfolds.