"Fed Whisperer" Nick Timiraos wrote an article on the eve of the release of August nonfarm payroll data, stating that tonight's jobs report will affect the size of the Fed's rate cut. If August nonfarm payrolls turn out to be another poor jobs report, it could lead to a significant 50 basis points rate cut by the Fed. However, if the employment situation is good, it will keep the Fed on track for a 25 basis points rate cut. Here is more content from the article.

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

The August recruitment and employment report, released on Friday, will be key in making this decision. A decent jobs report could prompt officials to start a series of rate cuts with a 25 basis points cut. If recruitment weakens or the unemployment rate rises, as it did in July, a larger rate cut will be imminent.

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

The tactical considerations for the next Fed meeting put officials in an uncertain position. With the economy and inflation slowing, as they expected earlier this year, there is more reason 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 next few meetings. However, the extent of the first rate cut will be closely watched as it reflects the economic outlook and its risks. The reasons for the officials' decision to cut rates by 25 basis points or 50 basis points will be very important.

If there is no sign that the soft jobs data from July will continue into August, some Fed officials may resist a 50 basis points rate cut. However, at the Fed's most recent meeting at the end of July, some officials who are open to rate cuts may support a 50 basis points rate cut in September if Friday's nonfarm report shows another jump in the unemployment rate and further slowdown in job growth, they will have broader support.

When the Fed last met in July, the job data showed an unemployment rate of 4.1%. But a month earlier, the reading was 4.3%, continuing to rise from the low point of 3.4% in April 2023. As the recent rise in the unemployment rate is partly driven by temporary rather than permanent layoffs, some officials have pointed out reasons to believe that the unemployment rate may decline in August.

Mary C. Daly, President of the Federal Reserve Bank of San Francisco, 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 occur 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, it's too late when you get the published data. So you can't rely solely on that published data because it's backward-looking," said Jerome Powell, Chair of the Federal Reserve, at a press conference on July 31. He stated that a 50-basis point rate cut is not something they are considering now. However, this was said before the release of the July jobs report two days later, which subsequently raised concerns about a larger cooling of the labor market. A series of employment surveys show that despite stable economic activity, the current tightness of the labor market is not as tight as in 2018 and 2019 before the pandemic.

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

The Federal Reserve is a consensus-driven institution that tends to take gradual action when economic prospects are uncertain. Therefore, the Fed tends to raise or lower interest rates in increments of 25 basis points. The last time the Fed shifted from raising rates to cutting rates was in 2019, when it first lowered the rate by 25 basis points. It also did the same during the growth scares of 1995 and 1998.

"The mindset I like is 'test and learn'," said Thomas Barkin, President of the Federal Reserve Bank of Richmond, in an interview last month. "Doing while learning is a better way."

Larger rate cuts of 50 basis points typically occur in emergencies, such as during the outbreak of the COVID-19 pandemic in March 2020, the credit market dysfunction in September 2007, and the significant cooling of manufacturing activity and the labor market in early 2001.

"There are very strong reasons to support a 50-basis point rate cut. While the labor market is not in recession, it is on thin ice. Even with good data on Friday, the weakness in the labor market is intensifying," said Diane Swonk, Chief Economist at Grant Thornton.

Editor/ping