According to the latest situation in the US labor market, the Fed may take an aggressive rate cut of 50 basis points in its first rate cut in September after initiating a rate hike cycle. After the release of weak non-farm payroll data, traders of interest rate futures have increased their bets on an aggressive rate cut. However, two important Fed officials did not reveal explicit support for the 50 basis points rate cut in their speeches on Friday.

Overall, the latest non-farm payroll data has failed to resolve the intense debate in the market about the magnitude of the Fed's interest rate cut in September. After the release of a series of economic data, including non-farm payroll, the camp that advocates a normalization pace of a 25 basis points interest rate cut and the camp that advocates a 50 basis points interest rate cut to boost the US economy have both expanded. Based on the pricing of interest rate futures and the bond market, the expectations for a 25 basis points and 50 basis points rate cut in September are roughly equal.

Nick Timiraos, a Wall Street Journal reporter known as the 'Fed Whisperer,' said that the latest non-farm payroll report did not effectively resolve the debate on interest rate cuts. Currently, the pricing for a 25 basis points and a 50 basis points rate cut is 'half-open.' These latest expectations mean that the suspense of how much the Fed will cut rates in September will likely be revealed at the last moment, during the Fed's FOMC monetary policy meeting on September 17th-18th.

However, the employment report has indeed intensified concerns in the market about a cooling US labor market, and concerns about a US economic recession have visibly increased. This was the logic behind the sharp drop in the US stock market on Friday, with the S&P 500 index recording its worst weekly performance since March 2023.

The US stock market prefers a 25 basis points rate cut rather than a 50 basis points rate cut.

The non-farm payroll data for August, which was released on Friday, showed that the number of jobs created by US employers in August was lower than economists' expectations, further indicating a significant cooling in the labor market and leading to a gradual expansion of the camp that bets on a 50 basis points rate cut.

For investors in the US stock market, the Fed's announcement of a 50 basis point rate cut may even trigger a new round of sharp declines in the US stock market. If the Fed chooses a 25 basis point reduction in September, it is basically equivalent to a "preventive rate cut," indicating that the Fed is relatively optimistic about the US economy's outlook. A 25 basis point cut is more based on preventing the US economy from entering a recession; while a 50 basis point cut largely signifies a relatively pessimistic view by the Fed on the US economy - meaning that Fed officials may see significant signs of an economic downturn, raising the possibility of a recession self-fulfilling. At the same time, a 50 basis point rate cut may not be the same as a "preventive rate cut," which could lead to panic selling in the US stock market due to recession expectations.

William Williams, the head of the New York Fed, and Fed Governor Christopher Waller made speeches at different events after the release of non-farm payroll data, admitting some easing in the labor market. However, Waller stated that he did not believe that the US economy is currently in or heading towards a recession, while Williams indicated that the current labor market conditions are more in line with a healthy labor market before the outbreak of the COVID-19 pandemic.

But Waller explicitly stated that he is ready to support the labor market at any time, echoing Fed Chair Jerome Powell's statements from last month. Waller also mentioned that if subsequent data shows a severe deterioration in the labor market, he will advocate for larger-scale actions.

Traders expect a rate cut of at least 25 basis points this month, but some are still betting that the monetary policy meeting in Washington on September 17th to 18th will result in a larger rate cut. After the non-farm payroll data release, traders increased their bets on the Fed implementing a 50 basis point rate cut in September. The CME 'FedWatch Tool' shows that the probability of a 50 basis point rate cut by the Fed rose to nearly 50% at one point, but the betting range has since been reduced, with the current probability at 30%-40%.

Undoubtedly, the Fed is making every effort to prevent an economic recession.

"Has the employment data really met the threshold for a 50 basis point rate cut? Based on past reasoning by the Fed, the answer is negative," said Kevin Flanagan, Head of Fixed Income Strategy at WisdomTree. "But can you provide effective counterarguments for a 50 basis point cut, especially considering the significant downward revisions in employment numbers over the past two months? That is also a reasonable viewpoint."

In August, the seasonally adjusted non-farm employment in the US increased by 0.142 million people, below the expected 0.16 million. At the same time, the previous value was revised from 0.114 million to 0.089 million, and the non-farm payroll additions for June were revised from 0.179 million to 0.118 million; after revisions, the total additions for June and July were 0.086 million lower compared to before the revisions. The US unemployment rate in August recorded 4.2%, in line with market expectations, reaching a new low since June this year and showing the first decrease after rising for four consecutive months.

Over the past three months, the average number of new hires in the US has been around 0.116 million per month, the lowest level since the peak of the COVID-19 pandemic in mid-2020.

Multiple signs indicate that employment in the United States is slowing down.

As the Federal Reserve prepares to hold its most anticipated policy meeting in over a year, this could spark a heated debate among policymakers, not to mention Wall Street economists and investors in the $27 trillion US bond market, with the focus of the debate centered on the magnitude and scale of the cuts needed in the coming months.

For Powell and his colleagues, the most critical issue is whether the slowdown in the US labor market could evolve into a severe US economic recession - a recession that they desperately hope to avoid. As more and more Americans struggle to find jobs, it could mean a negative growth in US consumer spending without strong income support, and a decline in consumer spending will undoubtedly have a serious negative impact on the US economy, given that 70% -80% of the components of US GDP are closely related to consumption.

Powell said in his speech: "This set of data no longer requires patience, but action." He added that he was "open to the size and speed of rate cuts."

After the labor market data was released on Friday, interest rate futures traders initially raised the probability of a 50 basis-point rate cut in September to 50%, but quickly brought this probability back to around 30%.

The fluctuating trading around the probability of policy easing this month still keeps the bond yield well below the current policy range of 5.25% - 5.5%. The yield on 2-year US Treasury notes is about 3.65%, indicating that bond traders still have confidence that the Federal Reserve will cut interest rates by about 2.4 percentage points by September 2025.

Some details suggest that the labor market still has resilience.

Some economists pointed out that some details in Friday's non-farm data report, such as the unexpected rise in the unemployment rate and wage growth, indicate that the labor market overall still remains resilient.

Gus Faucher, chief economist at PNC Financial Services Group, said that the Fed "has not panicked and believes the economy remains in good shape", and he has always expected the Fed to cut interest rates by 25 basis points this month. "A larger rate cut may indicate that they are more concerned about the US economy, and will be seen as a negative factor by the market. This may actually be detrimental to the macroeconomic goals that Fed policymakers want to achieve."

The minutes of the July meeting of the Fed showed that "several" officials had already seen sufficient reasons for a rate cut before the disappointing July employment data was released. Subsequently, Powell stated in a highly anticipated speech that neither he nor his colleagues would seek nor welcome further cooling of the labor market conditions.

At the Jackson Hole Global Central Bank Annual Meeting in late August, Powell announced to global investors that the Fed's interest rate cut cycle is about to begin. In less than 20 minutes of his speech, Powell made the most explicit signal from the Fed on interest rate cuts, not only officially mentioning that "the time for monetary policy adjustment has come", implying that the Fed's interest rate cut cycle is imminent, but also suggesting through various wordings that the Fed's future main task is to avoid economic recession and ensure a soft landing for the economy.

Some analysts quote these remarks, asking whether the non-farm data report for August released earlier on Friday constitutes the kind of "cooling" that Powell is so eager to avoid. "I think there is ample reason for a 50 basis point rate cut. I think it will be a fierce debate," said Diane Swonk, chief economist at KPMG. "Whether they can get there really depends on how many people among the Fed's FOMC voters are willing to agree."

In addition to deciding on the latest interest rates, Fed officials will also release a new set of economic forecast data at the upcoming monetary policy meeting, as well as their forecast for the appropriate path of interest rates for the next few quarters, the "dot plot" that global investors are focused on, which will more clearly indicate how quickly officials want to lower the benchmark interest rate.

Williams stated in his speech on Friday that Fed officials can shift policy to a neutral stance over time, depending on changes in data, economic outlook, and risks to achieving targets - a monetary policy stance that neither promotes nor restrains economic activity.

Editor/Emily