Near-term labor market developments will be pivotal in determining the pace at which the Fed front-loads rate cuts.
EXECUTIVE SUMMARY
Near-term developments in the labor market will be pivotal in determining the pace at which the Fed front-loads interest rate cuts, beyond the 50bp cut on September 18 which Fed Chair Powell sold as a “recalibration” of policy. With inflation receding and the rebalancing in the labor market warranting a less restrictive policy setting, the first cuts should be the easiest. While both payroll growth and unemployment dynamics will remain front of mind for the Fed, the scope for easing could be limited by inflation dynamics and increasingly cautious FOMC estimates of longer-run neutral rates.
- Economic activity: Comprehensive revisions have altered the quarterly path of GDP growth but don’t materially change a story of impressively robust growth amidst elevated real rates. Fiscal policy remains a wild card heading towards the presidential election on November 5 - whilst fiscal deficits seem likely to remain unsustainably large, they’re unlikely to increase at a sufficiently fast pace to continue acting as a tailwind to growth.
- Inflation: Core PCE inflation has on average been tracking below target for four months now and with the previously touted core non-housing services category only a touch firmer. This has opened the door for the Fed to front-load rates should labor conditions require, although core PCE inflation still running at 2.7% Y/Y warrants some caution over the magnitude of rate cuts in the near-term.
- Labor Market: Particularly strong supply side expansion has been a major driver of stronger than expected growth more broadly and the labor market is no exception, currently acting a barometer for broader economic health. The unemployment rising to 4.2% through the summer, triggering the Sahm Rule, has sparked the Fed to start its easing cycle with a 50bp cut to try and prevent a faster deterioration. Some forward indicators point to further increases.
- Outlook: Forecasts for near-term U.S. economic activity improved during the last three months, driven by domestic consumption and exports. That was at the expense of estimates of later periods, however.
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