The Fed just got the green light to cut rates

The June jobs report crushed expectations. The US economy created 224,000 jobs last month and put to rest fears that had been creeping into the market about a looming recession.

Financial markets are initially reacting to this report as a classic case of “good news is bad news.” Stock futures declined and Treasury yields rose after the report, with investors seeing this better-than-expected number as a sign the Federal Reserve will be less likely to cut interest rates to bolster a faltering economy.

But the June jobs actually outlines a simple reason for the Fed to cut interest rates later this month — there is still plenty of slack in the labor market.

Because while headline job gains in June topped expectations, wage growth missed estimates — wages rose 0.2% over the prior month and 3.1% over last year, both numbers missing the Street’s forecast by 0.1% — and the unemployment rate ticked higher on account of an increase in the labor force participation rate.

Both numbers are signs that the economic expansion which enters its 10th year this month continues to draw new workers into the labor pool.

And if the Fed’s plans to cut interest rates are aimed more at elongating this economic cycle than reacting to an economic expansion that is already rolling over, the argument in favor of reducing interest rates is straightforward.

A 25 basis point cut in July wouldn’t be an ‘overreaction’

Speaking last month at the Council on Foreign Relations, Fed chair Jay Powell noted that the various “crosscurrents” facing the US economy have increased in recent months. Most notably those related to trade.

Powell, however, cautioned that the Fed is “mindful that monetary policy should not overreact to any individual data point or short-term swing in sentiment. Doing so would risk adding even more uncertainty to the outlook.”

Cutting interest rates 50 basis points — as some Fed officials have argued is appropriate on account of inflation undershooting the central bank’s 2% target — is the kind of move that opens the door to market interpretations of an “overreaction” from the Fed.

A 25 basis point cut in July aimed at supporting a labor market that had slowed this year — but still shows signs of excess slack — with inflation running below target is more straightforwardly justified.

“[Friday’s] data are unlikely to stop the Fed from easing at this month’s meeting,” said Jim O’Sullivan, chief US economist at High Frequency Economics. “The well-signaled easing reflects officials’ worries about the potential drag on growth from trade-related ‘uncertainties,’ along with sub-2% inflation. However, the report adds to the likelihood that the easing will be of 25 rather than 50 basis points.”

The market on Friday may show signs of disappointment that an aggressive move from the Fed later this month is less likely. But the Fed’s path to trimming interest rates in advance of a more dire economic situation is now more clear than ever.

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Myles Udland is a reporter and anchor at Yahoo Finance. Follow him on Twitter @MylesUdland

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