The Fed Reserve is expected to continue with sharp interest rate increases in coming months to curb inflation, but growing U.S. unemployment and a slump in wage growth have traders betting that borrowing costs in 2023 may not end up quite as high as earlier predicted.
That’s the read from markets after the Labor Department posted on Friday that employers added a more-than-anticipated 315,000 in August, the jobless rate jumped 3.7% from 3.5% as more workers joined employment, and wage growth weakened from its previously torrid pace.
Traders still expect the Fed to implement a third 75-basis point rate hike at its Sept 20-21 meeting, raising the benchmark to 3%-3.25%, though they have reduced that possibility to 60% from 70% before the report, according to the CME Fedwatch tool.
Futures contracts closely tied to the Fed’s policy rate for 2023 show traders are currently pricing in a top Fed funds rate in the bottom of the 3.75%-4% range by March, falling from near the top of that range earlier.
James Knightley, the chief international economist at ING Economics, wrote:
“The August employment report paints a very positive picture. With wage growth coming in lower than expected it points to a slower pace of rate hikes after September’s expected 75 basis point move.”
Fed Chair Jerome Powell a week ago said the Fed will lift borrowing costs high enough to begin eating into growth, tame inflation, and soften the labor market, but said the size of this month’s rate hike would hinge on the “totality” of the data before then.
With prices mounting at more than triple the Fed’s 2% inflation target and at the highest in four decades, the jobs report will adhere to data in coming weeks on inflation and consumer prices expectations, both major concerns as the Powell Fed seeks to knock demand down to meet strained supply.
“The report was a step in the right direction, but it wasn’t a giant leap in that direction,” said Brian Jacobsen, senior investment strategist, Allspring Global Investments, who saw Friday’s job report as tipping the scales marginally toward a 0.5% point rate hike this month. He added:
“The key thing will be of course the inflation data. That will probably seal the deal as to whether it should be 50 or 75 basis points.”
For most Americans, the ultimate question is less about the exact size of September’s rate hikes and more about whether those working will be able to retain their jobs – and for the U.S. economy to avoid recession – as the Fed fights inflation.
State Street strategist Michael Arone said:
“There’s been this debate about soft landing versus recession for a while that economists and investors have been wrestling with. This job report supports the soft landing narrative.”
Still, it would take a lot of things to go right to attain that positive outcome, the majority of which is beyond the Fed’s control and which historically has little precedent. Prices of futures contracts settling next year indicated traders now await the Fed to raise its policy rate to about 3.83% by March, a fall from the 3.9% expected before the jobs report.
The Fed is expected to maintain rates in the 3.75%-4% range until after next summer, when market participants anticipate the central bank to relax policy slightly. Fed policymakers have rested on that scenario, with Cleveland Fed President Loretta Mester saying she does not see any rate cuts in 2023.
The Fed will announce fresh policymaker forecasts this month when it implements its next interest-rate decision.
