Fed to Scale Back Rate Cuts, But Jumbo Reduction on Weak Jobs Still Possible

Investing.com — The Federal Reserve is expected to make smaller cuts during its final two policy meetings of the year; however, a significant downturn in the labor market may compel the central bank to implement a larger cut following its recent 50 basis point reduction to safeguard the economy.

Analysts at Morgan Stanley noted in a recent report that, despite the unexpected size of the first cut, the overall tone from the Fed, combined with recent economic data, suggests that the central bank will likely opt for two 25 basis point cuts by year-end.

Nevertheless, the possibility of a more extensive rate cut remains on the table, according to the analysts, who pointed out that disappointing employment data could lead the Fed to adopt a more dovish stance.

If monthly payroll gains fall below 100,000, it could jeopardize the forecast for two 25 basis point cuts in the upcoming meetings. This viewpoint comes ahead of the employment figures for September, which are expected to be released soon.

Economic forecasts indicate that approximately 144,000 jobs were created in September, an increase from 142,000 in the previous month, with the unemployment rate projected to hold steady at 4.2%.

In September, the Fed surprised many market observers by enacting a 50 basis point cut, contrary to expectations for a more modest 25 basis point decrease.

Members of the Federal Reserve have indicated that the state of the labor market will play a crucial role in upcoming rate decisions. Atlantic Fed President Raphael Bostic, in a recent interview, expressed that significant weakness in job data would necessitate a more aggressive move by the Fed.

In a speech earlier this week, Fed Chairman Jerome Powell tempered expectations for additional large cuts, indicating that he forecasts two more reductions only if economic performance aligns with predictions.

While the labor market shows signs of softening, solid consumer spending has provided some reassurance to Fed officials that the economy might avoid a recession and achieve a so-called soft landing.

Consumer spending in August met expectations, with stronger growth in services compared to goods. Recent data indicates that consumer spending could be tracking at a 3.1% growth rate for the third quarter.

Morgan Stanley anticipates a general deceleration of economic activity toward the end of the year, but without entering a recession. The bank projects the real GDP will grow by 2.2% in the fourth quarter compared to the same period last year.

On the inflation front, prices continue to moderate. The Fed’s preferred inflation measure, the core personal consumption expenditures (PCE) price index, is slightly below initial expectations. The August core PCE inflation rate stands at 2.6% for 2024, aligning with the Fed’s median forecast from its September Federal Open Market Committee meeting.