Wall Street Frontline丨Matthew Martin decodes the Fed's Next Moves

Welcome to Wall Street Frontline.

On Friday, August 23, Federal Reserve Chair Jerome Powell delivered a keynote address at this year's Jackson Hole Economic Policy Symposium. He stated that it is time for policy adjustments, emphasizing that further cooling in the job market would be undesirable, and expressing confidence that inflation is nearing the U.S. central bank's 2% target.

At the same time, the Labor Department has revised employment figures for the year ending March 2024, showing 818,000 fewer jobs added than initially reported. This significant reduction raises concerns about the labor market's health. As the Federal Reserve prepares to cut interest rates in September, it is the largest downward revision since 2009, suggesting recent job growth may have been overestimated.

So how do the revised employment figures impact the overall health of the U.S. labor market? Today, we are joined by Matthew Martin, U.S. economist at Oxford Economics, to explore these important questions.

Wall Street Frontline： So first of all, let's start with this year's Jackson Hole speech. So do you think in terms of interest rate cuts, is this going to be a 25 BPS cut or 50 BPS cut?

Matthew Martin：Absolutely. I think there's a lot we can glean from Powell's speech at Jackson Hole. I think it's obviously no longer a debate whether the Fed is going to cut in September, but whether how aggressive they're going to be, and if that's going to be 25 BPS or 50 BPS. At this time, we're sticking with our forecast for 25 BPS rather than 50, but we do believe the August employment report is going to be crucial in determining how quickly they move. Overall, though, we do see the aggressive policy easing cycle priced by markets of about 100 BPS for the year a little bit too aggressive, and we're sticking with our rate cuts in September of 25 BPS and then followed by another one in December overall as the Fed pursues a gradual easing cycle rather than an aggressive one.

Wall Street Frontline：By the end of 2024, what range do you think the interest rates would fall between?

Matthew Martin：So that would put us in the 5% range at the top end of theirs, which again leaves the Fed with plenty of room if there is a sudden weakening in the labor market to begin cutting rates and address those issues. But again, at this time, we do not think there's enough weakness in the labor market to really pursue those aggressive cuts, and I think the Fed will want to do a wait-and-see approach with cutting, waiting, cutting, and waiting some more just to ensure that they aren't moving too quickly.

Wall Street Frontline：So the labor market has always been a very important indicator for the Federal Reserve's movements, policy adjustments. The recent revision by the Labor Department showed a significant downward adjustment in job growth figures. So how do you interpret this revision in the context of the overall health of the labor market?

Matthew Martin：Sure. The downward revisions were certainly eye-catching, and it's a reason why they made headlines. However, they're not without precedence, as you pointed out.

These numbers have occurred before. And not only that, at this time, it doesn't really change our outlook for the labor market at this time because it's a backward-looking metric unto itself. What we would say is that there are a couple things that might be playing into the larger-than-usual revision.

First is that the U.S. is in the middle of a surge in immigration, both legal and unauthorized. The Quarterly Census of Employment and Wages uses unemployed insurance records in order to come to the job growth data. However, those unauthorized immigrants would not be captured there, and therefore the jobs that they're working likely aren't captured as well.

So that could be playing into it. Second is this idea that there was a large surge in business applications when the economy reopened after COVID-19. As time goes on, it's only natural that some of those businesses are going to close up shop.

So it's likely that the BLS underestimated just how many business failures there were, but that's not to say that the labor market isn't strong at this point. Do you think there will be an interest rate cut in November? At this time, we don't see it. Again, I think they want to do a gradual approach to it and cut every other meeting until they reach their neutral rate, which is around 2.75, at least in our estimation.

It will take some time. I don't think they feel the need to cut quickly and that they feel the need that they can just sit and wait for the economy to continue growing.

Wall Street Frontline：Besides the message of cutting interest rates, are there any message that this morning's Jackson Hole speech has delivered to the market and investors?

Matthew Martin：Yes, I think the most important one is that the Fed explicitly said they're not willing to allow the labor market to weaken further.

And that's a crucial point because before, they had been emphasizing that their main mandate was to get inflation down. Exactly. But we think those balance between inflation and labor market has certainly moved towards the downside risk of the labor market and they're going to be more attentive to it.

They reiterated that with elevated rates at their current position, they have plenty of room to cut rates if they see that. However, until they see that data, again, we think it's going to be a gradual approach to cutting rates.

Wall Street Frontline：So the recent job reports, as well as adding the turbulence of the stock market, are raising concerns about potential economic recession. So economic recession is back to the table again. Do you think there will be a recession or still soft lending scenario?

Matthew Martin：At this time, we still think recession fears are overdone. First and foremost, the rise in unemployment rate has been mainly driven by an increase in supply rather than an increase in layoffs, which certainly is more encouraging.

Second is the fact that the engine of the economy, consumer spending, is still on a robust growth path. Consumers are benefiting from real wage increases, healthy balance sheets and low savings rates. Of course, this is underpinned by the idea that labor market needs to stay strong.

But at this time, we do see that as the case. And it's unlikely that consumption grows around 2% and the economy dips into a recession. So unlikely at this time for a recession to happen.

However, layoffs would call that into question. Layoffs could lead to weaker demands, which in turn leads to further weakness as businesses pull back and introduce more layoffs, which would be a discouraging cycle. Again, that's not our baseline.

And we do expect the economy to grow near 2% over the second half of the year as consumption stays strong overall.

Wall Street Frontline：So what is the biggest challenge that US economy is facing right now?

Matthew Martin：I think the biggest challenge is the fact that we are getting out of a period of unprecedented time during the pandemic. So we're operating in a bit of a data fog.

Seasonal patterns are kind of throwing a wrench into the Fed's plans. It's harder to read whether this is a one-time factor or a trend that's growing overall. Of course, we also are looking at inflation rates that haven't moved a ton over the year.

Inflation is down towards 2.5%. But it's kind of been in that range for the last couple months. So that last mile of wringing out inflation is really going to be tough for the Fed. But they are certainly aware that they have the tools to get the job done.And we think they are going to achieve a soft landing overall.

Wall Street Frontline：Soft landing is still okay. So you think there will be a soft landing scenario?

Matthew Martin：That's certainly the case. But if there was a sudden weakening in the labor market, it would be nearly impossible for that soft landing to occur. So labor market is the key indicator. And the Fed is going to be very aware of that fact.And they're going to be doing whatever they can to ensure that the sudden weakness doesn't spread into something larger.

Wall Street Frontline：So what is the most resilient part in US economy?

Matthew Martin：At this time, it really is the consumer at the moment. They have healthy balance sheets.

They do not have a ton of debt overall. There certainly are pockets of weakness among low- and middle-income houses. But as a whole, the economy still really is, there's a lot of demand out there.

And businesses are stocking up on inventories, knowing that that demand is still there. So clearly, even on the business side, they feel the consumer is still resilient enough. And as long as that's ticking along, the economy is going to as well.

There are pockets of weakness, probably in manufacturing and real estate. But those are going to be the sectors that benefit from lower interest rates overall. In fact, we saw that new home sales surged in July to one of their highest monthly gains in over a year, potentially pointing to the fact that lower mortgage rates are already stimulating more activity there. And we think that will continue as lower rates entail.

Wall Street Frontline：Some economists like Campbell Harvey, the father of inverted treasury yields, he said there's a lag effect between the interest rate cut and also the labor market. So do you think the labor market slowing sign is just the beginning?

Matthew Martin：It's likely that the labor market is going to continue to slow. It was going to be nearly impossible for the economy to continue to add 200,000 plus jobs on a monthly basis, as we saw before. There's likely to be some normalization. Businesses are pulling back on demand, but we're not seeing them begin to lay off people. They're really just pulling back on the amount of job openings that they're putting out there, which we think is a really crucial point. These businesses have worked really hard to hire these workers over the last two years, and we don't think they want to see them let go and then a year from now have to hire them back. So we really think they're going to do their best to continue keeping their jobs in-house and not going to layoffs in order to solve their problems at this time.