How the Fed Might Justify Rate Cuts in the Face of Hot Economic Data (April 8, 2024)

Some economists are already setting the stage for cuts, despite strong payrolls data

By Lisa Beilfuss

Economic data are complicating the Federal Reserve’s plans to cut interest rates this year. Something has to give, and it could be the data that officials choose to emphasize.

The March jobs report makes it harder to argue that the U.S. economy warrants interest-rate cuts anytime soon, even if fiscal policy is driving labor market gains. Alongside the much better-than-expected nonfarm payrolls number, the report showed an even bigger gain in the household survey and a positive net revision for January and February payrolls. That is to say that two elements of the bear case–disappointing household employment and negative revisions–flipped in March. 

It is possible that another strong jobs report, together with a renewed rise in inflation, delays the start of the Fed’s easing cycle until late this year or next year. 

But that outcome would require the central bank to prioritize its 2% inflation objective above reasonably presumed constraints, such as rising interest on government debt and the challenge higher yields pose to the Treasury market and banking system. That isn’t to mention the reality of election-year politics. Washington knows the incumbent party loses the White House every time there’s a recession quarter in an election year, notes Piper Sandler’s Nancy Lazar.

It is instead possible that central bankers begin to shift investors’ attention away from nonfarm payrolls and toward alternative labor-market measures in an effort to justify rate cuts. Powell has already done this on the inflation side by emphasizing “supercore” price indexes excluding food, energy and shelter.

Officials have cover to cast doubt on the reliability of the nonfarm payroll series. It seems no one really yet knows how immigration is affecting the employment figures, and the falling response rates to government surveys, by now well publicized, are rendering the data less reliable and subject to significant revisions.

There are subtle clues that this scenario may be about to unfold. Economist and Harvard professor Jason Furman, who was a top economic adviser to Barack Obama and worked in the Clinton administration, threw cold water on the usefulness of payrolls Friday. 

“I've given up on using job growth to assess anything regarding inflation or overheating,” Furman tweeted after the jobs data dropped Friday. 

Consider as well a tweet Friday from economist Ernie Tedeschi, who was until recently President Joe Biden’s chief economist at the White House Council of Economic Advisers. “The U.S. economy is clearly growing at a strong pace. The question for the Fed is how much of this growth is supply-driven,” Tedeschi wrote. 

Tedeschi’s comment is reminiscent of the logic behind transitory-inflation arguments that began in 2021. Then, “transitory” proponents argued that price increases were about pandemic-related supply disruptions and not about demand.

Now, Tedeschi is talking about a potentially massive increase in labor supply due to immigration. He points to a recent report from the Hamilton Project that says projections from the Congressional Budget Office suggest the trend in jobs growth because of immigration and is now closer to 200,000 a month, up from a prior 100,000.

“The difference between trends of 100,000 and 200,000 a month has profound implications for policy. The former means the labor market is hot and has plenty of momentum. The latter means we're much closer to a sustainable equilibrium and should be more wary of risks of overly-tight policy,” Tedeschi says. 

Adopting the kind of thinking put forth by the likes of Furman and Tedeschi would help the Fed explain rate cuts if they really are intent on easing policy in the face of strong headline data. Key to this scenario would be the Fed’s redirection of investors’ focus from nonfarm payrolls to alternative labor-market measures, such as employment data from the Institute for Supply Management.  

In March, both the ISM’s manufacturing and services job indexes both came in below the key 50 threshold that separates expansion from contraction. As SMBC Nikko Securities Americas economist Troy Ludtka notes, this means both the manufacturing and services sectors expect to shrink employment. 

“These two stars do not align often, but when they do it tends to coincide with recession and private job losses,” Ludtka says, adding that in 80% of past instances where the employment components of both the ISM manufacturing and ISM services reports printed below 50, private jobs fell. Both series have registered below 50 in three of the past four months.  

There are labor indicators beyond ISM metrics running contrary to nonfarm payrolls. Ludtka points to a steady decline in private-sector job openings in the Job Openings and Labor Turnover Survey (JOLTS), a steep and steady drop in the number of temporary workers, and recession territory for manufacturing overtime hours. 

The latest data from outplacement firm Challenger, Gray & Christmas showed the number of jobs U.S. employers announced in the first quarter dropped 48% from a year earlier, the lowest number of announced hiring plans since 2016. Announced job cuts meanwhile rose 7% in March from a month earlier. Economists at Pantheon Macroeconomics note that the Challenger layoff announcements lead initial jobless claims by three to six months.  

Then there is the relentless decline in full-time employment, says David Rosenberg of Rosenberg Research. The point is an important one as many strategists debate the recent surge in part-time employment. It is oversimplifying to say that a rise in part-timers is bad. In March, the jump in part-time work was driven by those who said they were working part time by choice, not because they couldn’t find part-time work. 

But it is also incorrect to dismiss the rise in part-time labor because it was driven by those choosing to do so. Michael Green, chief strategist at Simplify Asset Management, says the patterns of part-time work for economic reasons (unable to find full-time work) versus part-time work for non-economic reasons “looks exactly like unemployment, which is why many of us monitor these (now rising) relationships.” 

There are plenty of indications that the labor market isn’t as strong as nonfarm payrolls suggest. To gauge how likely the Fed is to embark on rate cuts in the face of strong headline jobs numbers, investors should watch for officials to highlight lesser-discussed and more accommodating labor-market measures. Officials say they are data dependent, but they get to pick the data.