U.S. economy and jobs market are showing cracks. Fed rate cuts are not far off.

By Jeffry Bartash

Unemployment rate has risen to 2.5-year high

Forget the summer heat: The economy appears to have caught enough of a chill that the Federal Reserve is likely to cut interest rates soon.

The latest evidence? A June jobs report where the 206,000 increase in employment was weaker than the headline number implied.

A broad slowdown in hiring, along with cooler inflation, has paved the way for the Fed to reduce borrowing costs as soon as September, economists say.

Some Wall Street DJIA SPX COMP economists even wonder if the Fed is waiting too long. High interest rates put in place by the Fed to quell inflation could damage the economy and, in a worst-case scenario, threaten the three-year-old economic expansion.

"We are seeing more signs of a slowing economy," said Richard Moody, chief economist at Regions Financial, who thinks a July rate cut should be on the table. "It is obvious the labor market is continuing to cool."

Cracks in the economy

The prospect of a rapidly weakening economy seemed far-fetched just several months ago. The U.S. added a surprisingly large 267,000 new jobs a month in the first quarter, and inflation surged again early in the new year.

The result: The Fed put off plans to cut interest rates in the spring until it got more evidence inflation was slowing again. Instead, the central bank kept its benchmark short-term rate at a 23-year high.

The effects on the economy have become more evident since then.

Stiff borrowing costs discouraged businesses from investing and extended a slump in manufacturing. And consumers have been stymied from buying homes, new cars and other big-ticket items.

Gross domestic product, the official scorecard of the U.S. economy, slowed to 1.4% in the first quarter, from 3%-plus in the second half of 2023. And second-quarter GDP is on track to be similarly pedestrian.

Devil in the details

The June jobs report underscored the soft underbelly of the economy.

On the face of it, 206,000 new jobs in June is a strong number.

The details were not nearly as strong, though. For one thing, the government created one-third of the new jobs last month and private-sector hiring lagged. That's not a good sign.

"Looking under the hood, it's notable to point out that government payrolls appear to be bolstering the numbers while private payroll growth is slowing," said Emily Overton, capital markets analyst at Veterans United Home Loans.

The government also chopped prior estimates of job gains in May and April, pointing to a big slowdown in hiring in the spring.

The average number of new jobs added each month in the second quarter sank to 177,000, from 267,000 in the first quarter.

The loss of momentum in the jobs market has been evident in other surveys of job openings, layoffs, businesses' hiring plans and the unemployment rate.

The jobless rate rose in June to a two-and-half-year high of 4.1%, from as little as 3.4% some 14 months ago. And the number of unemployed in June climbed to 6.8 million, from just 6 million 12 months ago.

"A steadily rising unemployment rate ... raises concern of a sharper weakening," economists at Citibank wrote in a note to clients.

Easing inflation

Inflation also appears to be cooling. After a first-quarter surge, inflation began to slow in April and prices were flat in May, government figures show.

The rate of U.S. inflation using the Fed's preferred personal-consumption expenditures price index slowed to 2.6% in May, nudging to closer to the central bank's 2% target.

The June consumer-price index, due next Thursday, is also expected to show a scant 0.1% increase in overall U.S. inflation.

What it all is starting to point to is a Fed rate cut in September. Wall Street now views the odds of a interest-rate cut at the bank's Sept. 17-18 meeting at 71%.

-Jeffry Bartash

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07-06-24 0604ET

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