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Expectations for a supersized rate cut in September have been losing momentum as recent economic data clarified the outlook, indicating that recession fears were overstated. However, the August jobs report could rekindle speculation about a large September rate cut.

Labor Market Now in Monetary Policy Driving Seat

“Whether the Fed delivers a 50bp cut in September will come down to the August jobs report, out in early September,” stated Citi economists, led by Andrew Hollenhorst. The increased significance of the labor market is evident as recent inflation readings suggest that a September rate cut is almost guaranteed. Citi indicated that inflation is likely becoming less of a concern for the Fed, shifting attention to the labor market.

A third consecutive month of sub-2% annualized core CPI inflation makes a September rate cut highly probable, which should keep Fed officials focused on employment and economic growth. A 50 basis point cut may be sanctioned by Fed officials if the unemployment rate remains at 4.3% or rises, with the possibility even if unemployment drops marginally.

Citi’s forecast for a larger cut hinges on a further decline in the labor market. Fed Chairman Jerome Powell has reiterated the heightened focus on the labor market and that the central bank would act in case of any unexpected weakening. “If the labor market were to weaken unexpectedly or inflation were to fall more quickly than anticipated, we are prepared to respond,” Powell noted at the July 31-August 1 FOMC press conference. He acknowledged that while the labor market has cooled back to pre-pandemic levels, it remains robust but not overheated.

Was Weakness in the July Jobs Report ‘Transitory’?

These comments came before the July nonfarm payrolls report revealed a rise in the U.S. unemployment rate by 0.2% to 4.3%, igniting recession fears and causing some market panic. Citi indicated that the increase in the unemployment rate from 3.4% is concerning, yet recent dips in jobless claims suggest that the soft jobs report in July may have been ‘transitory.’

This reassuring data has elevated the odds to approximately 75% that the Federal Reserve will ease by 25 basis points in September, reducing the likelihood of a 50 basis point cut to 25%, down from 51% in the previous week.

Powell to Keep Cards Close at Jackson Hole

With weeks remaining until the August nonfarm payrolls report is released on September 6, Powell’s remarks at Jackson Hole next week may provide crucial insights into the Fed’s potential actions. However, he is expected to maintain a cautious stance as significant data influencing policy remains forthcoming.

Given that the September policy decision will depend on data not yet available, Powell is unlikely to offer definitive guidance on whether the cut will be 25bp or 50bp. Citi also noted there is a risk that Chair Powell might suggest the need to adjust policy settings more quickly to reach a neutral rate.