Labor weakness primes the Fed for the start of consistent rate cuts

July job openings

Job openings continued declining as the U.S. labor market continued to cool. Last week, the Bureau of Labor Statistics reported that job openings in July fell to 7.67 million, down from 8.18 million in June. Although the total openings of 7.67 million is higher than the 2019 average of 7.15 million, the job openings rate tells a slightly different story.

The job openings rate is the number of job openings divided by the total number of jobs and job openings combined. It provides a better picture of the total available jobs relative to the workforce, and a lower percentage indicates weaker labor demand and fewer job openings. That said, the job openings rate fell to 4.60% in July, which marks its lowest level since 2020 and shows the continued normalization within the labor market. For perspective, the job openings rate averaged 4.50% in 2019.

August nonfarm payrolls

Nonfarm payrolls told a very similar story to Job openings. The U.S. gained 142,000 jobs in August, falling below expectations of 165,000. June numbers were revised down from 179,000 to 118,000, while July was revised down from 114,000 to 89,000, making the total change 86,000 lower than previously reported. The unemployment rate did meet expectations, ticking down to 4.20% after rising to 4.30% in July.

Average hourly earnings increased by 14 cents to $35.21, marking a 3.83% increase over the last 12 months. The labor force participation rate held steady at 62.70% after 120,000 individuals joined the labor force, helping to push the unemployment rate down to 4.20%. The number of people employed part-time for economic reasons, or those who would prefer full-time work, but either can’t find full-time work or their hours have been reduced, was reported as 4.80 million. That is up significantly from this time last year when it was 4.20 million and shows that many individuals are struggling to find full-time jobs.

Although those figures are certainly worse than we’ve seen over the last few years, they are more in line with historic standards. The average increase in hourly wages in 2019 was 2.98%, unemployment was 3.60%, and 166,000 jobs were added each month on average.

Market reaction

As the labor market continues to normalize back to levels similar to 2019 and beforehand, inflation is expected to continue cooling, and the market expects the Fed Funds rate to be comparable to pre-pandemic levels, which were 1.50% to 1.75% in December 2019. After an initial jump following the nonfarm payroll number release, interest rates fell to a fresh 52-week low on Friday. After briefly “un-inverting” on Wednesday, the 2-year and 10-year treasury yields have again normalized and ended the day with a 6-basis-point spread between them. The 10-year finished the week at 3.72% and the 2-year finished at 3.65%. This week marked the first time that the 10-year yield has gone above the 2-year yield since July 2022, showing the market’s broad expectation that the Fed will begin cutting rates starting in September and consistently continue until well into 2025.

Federal Reserve Governor Christopher Waller noted on Friday, “As of today, I believe it is important to start the rate-cutting process at our next meeting.” He went on to explain, “While I expect that these cuts will be done carefully as the economy and employment continue to grow, in the context of stable inflation, I stand ready to act promptly to support the economy as needed.”

With that in mind, 100.00% of the market expects at least one rate cut in September. As of Monday morning, 25.00% of those participants expect two rate cuts. The graphic below, from the CME Group’s Fed Watch Tool, shows after the first cut in September, the market expects 125 basis points of cuts by the end of 2024 and an additional 100 basis points of cuts by September 2025.

Final takeaway

As rates continue to decline, it’s important to remember that by hedging now corporates can lock in the anticipated rate cuts. Similarly to this time in 2023, the market overoptimistically expected rate cuts to materialize in the first half of 2024 due to weaker inflation and jobs data, but those never came to fruition after inflation re-accelerated. Should the economy continue to add jobs, or inflation picks back up as the result of potential fiscal policies of either presidential candidate next year, rates could certainly remain higher for longer than the market currently anticipates. Getting inflation back down to 2.00% from the current 2.50% could prove significantly more challenging than the rapid decline we’ve seen over the last year.