The August ADP payroll report, released on Thursday, has significantly shifted the odds towards a 0.5% interest rate cut by the Federal Reserve in its upcoming meeting two weeks from now. The report showed a sluggish job market, with only 99,000 jobs added in August – falling short of the anticipated 140,000. This marks the fifth consecutive month of slowing private payroll growth, raising concerns about the overall health of the economy.
Economists, like Jeffrey Roach, chief economist for LPL Financial, believe this data could foreshadow a weaker-than-expected official payroll report on Friday. A weaker report would further strengthen the case for a larger rate cut. “If the payroll report surprises investors and comes in weaker than expected, the likelihood of a 50 basis point cut increases at the upcoming Fed meeting,” Roach stated on Thursday.
The ADP report revealed a mixed bag across different sectors. The service sector added 72,000 jobs in August, while goods producers added 27,000. The construction and education/health services industries saw the largest employment gains, adding 27,000 and 29,000 jobs, respectively. However, professional/business services shed 16,000 jobs, while manufacturing lost 8,000 and information dropped 4,000.
Year-over-year pay increases remained stagnant at 4.8% in August, mirroring July’s figure. However, pay raises for job-switchers saw a slight uptick from 7.2% in July to 7.3% in August. This suggests that companies are struggling to retain workers and are having to offer higher salaries to attract new talent.
Adding further weight to the argument for a larger rate cut, the unemployment benefits claims for the week ending August 31st fell from 232,000 to 227,000, beating the expected 230,000. This indicates a tightening labor market, with fewer people filing for unemployment benefits.
Roach highlighted that smaller companies are facing more pressure than larger companies to reduce labor costs. He also pointed out the trend of workers switching jobs and receiving higher pay raises compared to those who remain in their current positions.
Bill Adams, chief economist for Comerica Bank, echoed the sentiment of a potential 0.5% rate cut. He believes that the combined weight of the ADP report and the Fed’s August Beige Book report, which was released on Wednesday, strengthens the case for a larger rate cut. “The odds of a half percentage point rate cut at the Fed’s next meeting are a little larger than they seemed yesterday,” Adams said. “We still see a quarter-percent cut as more likely but a half-percent cut wouldn’t be a surprise.”
Both reports indicate that the economy slowed down during the summer, not just due to Hurricane Beryl’s impact. The financial markets currently reflect a 50-50 probability of the Fed cutting interest rates by 0.5% on September 18th versus a smaller 0.25% cut.
The Fed faces a delicate balancing act. On one hand, it needs to prevent the slowdown in job growth from becoming a self-perpetuating decline. On the other hand, it needs to avoid reigniting inflationary pressures as rate cuts help credit-sensitive parts of the economy recover. The upcoming Fed meeting promises to be a pivotal moment, with the decision on the rate cut likely to have significant implications for the US economy.
