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Jobs Day Bust Still Isn’t Enough for Instant Fed Cut

Policy makers will want at least one more month of data to confirm the labor-market slowdown. 

Jobs Day Bust Still Isn’t Enough for Instant Fed Cut
Jerome Powell, governor of the U.S. Federal Reserve, speaks during a Senate Banking Committee hearing in Washington. (Photographer: Andrew Harrer/Bloomberg)

(Bloomberg Opinion) -- At this time a year ago, President Donald Trump stunned bond traders by tweeting that he was “looking forward to seeing the employment numbers at 8:30 this morning,” about an hour before the crucial data came out.

This was widely considered to be a nudge and a wink about better-than-expected figures, and, indeed, just about every metric in the Labor Department’s May 2018 report beat analysts’ estimates. The Federal Reserve would raise interest rates a couple weeks later.

Fast forward to the present, and the situation has reversed. The jobs report on Friday showed weakness across the board, with payrolls rising just 75,000 in May, missing all estimates in Bloomberg’s survey, which called for 175,000. Moreover, April’s gains were revised down to 224,000 from 263,000, and average hourly earnings rose only 3.1% from a year earlier, falling short of expectations for 3.2% growth. The Fed will almost certainly face increased pressure to lower interest rates sooner rather than later.

Jobs Day Bust Still Isn’t Enough for Instant Fed Cut

The bond market, of course, is positioned for such a move after a relentless rally over the past few weeks sent benchmark Treasury yields to their lowest levels since 2017 and created a sharply inverted yield curve from three months to 10 years. The 10-year yield set a new recent low of 2.0517% after the employment data.

As the Trump administration escalated trade conflicts with China and Mexico, and bond traders piled into bets on interest-rate cuts, I have been cautioning that Fed Chair Jerome Powell and his colleagues would want to see hard evidence about the impact on the U.S. economy before making any sort of move. This payrolls report was a big miss and a big deal, but I still don’t think it’s sufficient for them to instantly lower their benchmark rate on June 19.

However, it makes the July 31 decision loom large. Fed funds futures are showing a quarter-point cut almost fully priced in for that meeting. It’s not hard to imagine Fed officials signaling this month that if the labor market continues to soften, they could “soon” ease policy to sustain the economic expansion — effectively adopting St. Louis Fed President James Bullard’s language. But at the same time it would give them a way out of moving if the June jobs report and other data bounce back. 

What the Fed needs for now is to bide its time. Moments after the payrolls report, news broke that the U.S. is giving some China products a bit longer to avoid an increase in tariffs. It’s anyone’s guess what the White House’s reaction will be to what appears to be a weakening labor market. But the president does like to say things like this, from May 19:

Are tariffs worth jeopardizing this “jobs, jobs, jobs!” mantra? Remember, markets appeared concerned, but not alarmed, when Trump’s trade war was only with China. Throwing Mexico into the mix, based on seemingly arbitrary metrics and when the two countries already had a trade deal in place, is what pushed traders over the edge. Even just resolving the U.S. dispute with its southern neighbor could reverse some of the mounting uncertainty. 

It’s important to note that interest-rate cuts are a highly imperfect way to deal with geopolitical trade disputes. But as my Bloomberg Opinion colleague Tim Duy wrote this week, the Fed simply responds to shocks in a systematic fashion. It may seem heavy-handed, but right now lowering its benchmark rate is the only tool in its toolbox.

Still, to drop interest rates 12 days from now seems too soon, though the Powell-led Fed has exceeded markets’ dovish expectations before. Most likely, policy makers subtly shift to raise the possibility of a cut down the line — if not explicitly in their updated “dot plot,” then in Powell’s press-conference language. 

Meanwhile, the rhetoric won’t die down. “If there is a meaningful slowdown, the Fed can come in and cut rates by 50 basis points,” Subadra Rajappa, head of U.S. rates strategy at Societe Generale, said in a Bloomberg Television interview Friday. “There’s always the risk that if they wait, they’re going to have to do more.”

Conversely, the market may be giving the central bank some breathing room. As Ward McCarthy, the chief financial economist of Jefferies LLC pointed out in a note on Friday, “To the extent that the FOMC has inclinations to act pre-emptively, with the recent decline in rates, the market has basically done the Fed’s job for them.” He added, “the Fed is going to be patient and let the data point the way.”

A little monetary stimulus might not fix Trump’s trade wars, but, as my Bloomberg Opinion colleague Mark Whitehouse noted, it wouldn’t hurt the job market. And that’s a crucial part of the Fed’s mandate. In his heart of hearts, I believe Powell would prefer to keep interest rates where they are — still low by historical standards and slightly below officials’ estimates of neutral. If the labor market shows further signs of rolling over, though, he might not have a choice. And that’s when bond traders will pounce.

To contact the editor responsible for this story: Daniel Niemi at dniemi1@bloomberg.net

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Brian Chappatta is a Bloomberg Opinion columnist covering debt markets. He previously covered bonds for Bloomberg News. He is also a CFA charterholder.

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