The Federal Reserve appears likely to reset rate-cut expectations at its March 20 meeting, which might temporarily knock the S&P 500 off its stride. At this point, only a soft February jobs report — which isn't what Wall Street expects — can avert that outcome.
Friday's Jobs Report
Economists expect the monthly Bureau of Labor Statistics jobs report to show that employers added 190,000 payroll positions last month, including 150,000 in the private sector. The unemployment rate is seen holding at 3.7%.
Revisions to January's surprising 353,000 payroll gain, including 317,000 private-sector jobs, could be an important factor. The initially reported gain of 443,000 private-sector jobs in January 2023 was eventually revised down to 359,000.
The average hourly wage jumped 0.6% in January, which lifted 12-month wage inflation to 4.5%. But the outsized monthly gain at least partly reflected bad weather that kept a high number of wage-earners sidelined (though still officially employed), while higher-earning salaried workers still got their paychecks. Although winter storms could still have some effect in February data, economists expect 12-month wage growth to ease to 4.3%.
Fed Policy Implications
Federal Reserve Chair Jerome Powell reiterated in testimony to Congress this week that policy easing is still likely "at some point this year."
Powell explained that downside risks for employment and upside risks for inflation "have been moving into better balance." But that still implies that upside risk to inflation is the bigger concern.
Powell noted that cutting rates too soon or too much could reverse progress in bringing inflation down "and ultimately require even tighter policy." On the other hand, Powell said that waiting too long to ease policy "could unduly weaken economic activity and employment."
Powell is essentially saying that the Fed will be nimble in reacting to clear evidence of a hiring slowdown. That would probably require private payroll gains to slow to less than 100,000 per month over a three-month period vs. the 249,000 average over the past three months.
Some economists think the first evidence of a slowdown could show up in Friday's jobs report. Oliver Allen, senior U.S. economist at Pantheon Macroeconomics, says his firm is forecasting just a 75,000 rise in private payrolls for February, citing Homebase small business employment data.
March 20 Rate-Cut Projections
In the December batch of quarterly projections, Fed policymakers penciled in 75 basis points worth of rate cuts this year — the equivalent of three quarter-point moves — and another full percentage point worth of rate cuts in 2025.
But here's what we now know: Despite seven months of tame inflation data ahead of its Jan. 31 meeting, the Fed got to the threshold of greenlighting rate cuts and blinked. The powerful S&P 500 rally appeared to play a significant role, with the Fed worried about fueling the AI stock boom with rate cuts.
On top of worries about 1990s-style irrational exuberance, Atlanta Fed president Raphael Bostic, in a Feb. 15 speech, highlighted the risk of "pent-up exuberance," with businesses reacting to rate cuts with a resumption of hiring and investment.
Powell stressed that a decision to start a rate-cutting cycle is a "highly consequential" one that the Fed wants to get right.
Fed policymakers seem to have arrived at a consensus about the need to reset expectations over how rate cuts will proceed following the first cut. Instead of a rate cut every other meeting, the Fed might set a pace of one for every three meetings or every six months. If things go smoothly, that could mean two quarter-point cuts this year and two or three in 2025, leaving the Fed's key rate above 4% through the end of next year.
Bare in mind that it would only take a small shift for the Fed to erase one planned rate cut this year. December projections showed that eight Fed policymakers expected two cuts or fewer this year, while 11 saw three cuts or more.
Fed Rate-Cut Odds
Markets currently see 74% odds of the first Fed rate cut coming by the June 12 meeting. Currently, markets are pricing in a year-end Fed funds rate of 4.45%, which implies that Wall Street sees four quarter-point rate cuts as more likely than three.
Markets may be in for a surprise on March 20, though Wall Street might ignore Fed guidance.
S&P 500
The S&P 500 climbed 1% in Thursday astock market action, hitting a new record high. The Nasdaq rallied 1.5% but remained just below its March 1 high, indicating a bit of a change in market leadership as a few of the Magnificent Seven have come under pressure.
The S&P 500 has continued to press higher as Treasury yields have pulled back this month on very tentative signs of easing growth.
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