September Economic Commentary: Federal Reserve Prepares for Rate Cuts as Inflation Eases and Labor Market Cools
August was a pivotal month in the minds of many as Chair Powell of the Federal Reserve strongly intimated that the rate-cutting phase of monetary policy is about to commence at their upcoming meeting on September 18. Now that the risks of elevated inflation appear to be subsiding, the Fed is more focused on the health of the labor market. With consumers being the engine of the U.S. economy, the Fed does not seek or welcome any further cooling in labor market conditions.
Inflation
Underlying inflation eased for a fourth consecutive month on an annual basis in July, keeping the Fed on track to lower interest rates in September. The headline CPI for July was +0.2% after a -0.1% monthly reading in June, bringing the year-over-year number down to 2.9%. Core CPI was 0.2% in July after a 0.1% reading in June, bringing its year-over-year number down to 3.2%. The Fed’s preferred measure of inflation, the Core Personal Consumption Expenditure Index (PCE), has had back-to-back monthly readings of +0.2%, keeping its year-over-year reading at 2.6%. This string of soft monthly inflation readings is giving the Fed the necessary confidence that year-over-year inflation pressures are moving sustainably toward their 2.0% target and satisfying their mandate of price stability.
Productivity & GDP
The final reading for productivity and unit labor costs for second quarter 2024 provided further support for ongoing easing of inflation pressures. Non-farm business productivity grew at a 2.5% annualized rate (+2.7% year-over-year) and unit labor costs grew at a 0.4% annualized rate during the quarter (+0.3% year-over-year). Year-over-year unit labor costs peaked at 6.5% in first quarter 2022 and have now declined for nine consecutive quarters.
Second quarter 2024 real GDP was upgraded to 3.0% annualized from 2.8%. The improved reading was primarily due to an upward revision to personal spending from 2.3% to 2.9% in the quarter.
Consumer Spending
Looking at monthly data, July showed real consumer spending growing +0.5% (+2.7% year-over-year). As has been the case since the beginning of 2024, real disposable income (+0.3% in July and +1.1% year-over-year) has lagged spending, causing the savings rate to decline to a two-year low of 2.9%. Consumers are spending more on non-discretionary items and less on discretionary items as excess savings have been mostly depleted and higher delinquency rates for consumer loans are being reported.
Manufacturing
The manufacturing sector remains under pressure as indicated by the ISM Manufacturing Index registering below 50 in 21 out of the last 22 months. August’s reading was 47.2, and any print below 50 indicates contraction. Only five out of the 18 manufacturing sectors reported any growth in August, similar to July. Weakness was most pronounced in New Orders, Production (now at its lowest level outside of the pandemic since 2009) and Employment.
Labor Market
The most closely watched report of the last month was the employment report released on Friday, September 6. The report showed that the labor market is continuing to cool, but it is not collapsing. Nonfarm payrolls rose by 142,000 in August, but job growth in June was revised down 61,000 to 118,000, and job growth in July was revised down 25,000 to 89,000 – the weakest July reading since 2018. The unemployment rate declined 0.1% to 4.2% as the labor force increased by 120,000 in August and employment in the Household Survey increased by 168,000. A broader measure of unemployment, the U-6 rate, moved up to 7.9%, the highest level since October 2021. The average hourly earnings in August increased 0.4% bringing the year-over-year figure to 3.8% from 3.6%.
The cooling of the labor market is evidenced by the fact that while the Household Survey showed an increase of 168,000 – included in that number was an increase of 264,000 people working part-time for economic reasons – a growing number of employees are being furloughed to part-time. Full-time employment declined 438,000 in August and is down 0.76% year-over-year. Multiple job holders now comprise 5.3% of the workforce, which is the highest level since April 2009.
Earlier in August, the Quarterly Census of Employment and Wages (QCEW) showed that nonfarm payrolls over the year from April 2023 to March 2024 were revised lower by 818,000, a reduction of 28% in the level of job creation. That was an average of 68,000 fewer nonfarm employees per month than originally reported.
The JOLTS (Job Openings and Labor Turnover) report for July showed that job openings declined by 237,000 to the lowest level since January 2021. The ratio of job openings to unemployed has now fallen to 1.07, lower than seen throughout 2019. Meanwhile, the Challenger report for August showed that layoffs were the most for any August since 2020, and hiring announcements were down to the lowest level for any August since 2004 (the inception of that data set).
The Fed & Interest Rates
Although there was no Federal Open Market Committee (FOMC) meeting in August, Chair Powell delivered a speech at the Jackson Hole, Wyoming gathering of bankers clearly laying out that the time for interest rate cuts has arrived. While the pace of interest rate cuts will be determined by developments in the labor market, Powell stated that his confidence that inflation is sustainably moving toward the Fed’s 2.0% target has improved. Consequently, the balance of risks to the Fed’s two mandates (price stability and maximum employment) has changed with upside risks to unemployment being greater than upside risks to inflationary pressures. The Fed is concerned that the cooling labor market will weigh on spending growth and economic strength going forward.
Powell’s concerns were supported by the latest readings from the September 4 edition of the Fed’s Beige Book which stated that economic activity in nine of the 12 Federal Reserve districts was either stagnating or contracting. That’s up from five out of the 12 in the previous Beige Book published six weeks ago.
Markets are pricing in a total of four interest rate cuts over the coming three FOMC meetings (September 18, November 7 and December 18). Interest rates have fallen across the yield curve since the end of July with the 10-year Treasury down 40 basis points to 3.73%, and as of Friday, September 6, the 10-year/2-year portion of the curve has returned to a normal position with the 10-year yielding more than the 2-year. This portion of the curve had been inverted since July 2022.
