Soft Jobs, Sticky Prices: The Fed’s Balancing Act

The markets’ expectations for a rate cut in the US have heightened, but there is a fair amount of noise surrounding the decision. Investors are still optimistic, yet the conditions for consumers are under question. From rising jobless claims to sticky inflation and weakening consumer sentiment, the dynamics facing the Federal Reserve (“the Fed”) have become more complex.

Understanding the Fed’s Rate Cuts

What is the Federal Funds Rate?

The Fed sets the federal funds rate — the benchmark interest rate at which banks lend to each other overnight. It influences borrowing costs for households and businesses, from mortgages and car loans to corporate debt.

Why do rate cuts matter?

When the Fed lowers rates, it reduces borrowing costs, which in theory supports consumer spending and business investment. Cheaper credit can boost demand, employment, and growth. But cutting too aggressively when inflation is still high risks stoking price pressures again.

The challenge now lies in balancing weakening labour market data with stubbornly elevated inflation – a balancing act that is defining the Fed’s current policy dilemma.

What’s Driving the Fed’s Decision?

Labour Market Weakness

Jobless Claims is a statistic reported by the US Department of Labor indicating how many people are claiming unemployment benefits weekly. Essentially it is a show of strength regarding the US labour market, and an important leading indicator of the state of the economy.

Recent data has shown cracks as the figure surged to its highest level in almost four years, which was coupled with a low figure for August Payroll growth – an indicator of growing job availability.

The softer labour market adds urgency for the Fed to act, as weaker employment often leads to slower spending and a broader economic slowdown.

Sticky Inflation and Tariff Pressures

Headline CPI for August rose 2.9% year-on-year, while core inflation – which excludes food and energy – was higher at 3.1%. Tariff related pressures and persistent service-sector price rises have led to stickier than expected inflation reads.

Rate cuts are expansionary for the economy, with lower borrowing costs intended to stimulate higher spending. Though, this could create even higher prices and undermine the Fed’s progress against inflation thus far.

This is where the balancing act becomes apparent, does the Fed cut and stimulate the job market, but risk pushing inflation higher, or does it hold off and risk a downturn in jobs and growth.

Consumer Confidence Fading

Consumer confidence is a measure of how optimistic consumers are about their financial situation alongside the state of the economy. This figure slipped in August reflecting weaker assessments of both current and future conditions. High prices are weighing on household finances, and a weaker job market is providing little support.

Falling confidence translates into lower discretionary spending, which drags on the economy. But what would be the best way to tackle the issue? Combat inflation to give consumers more purchasing power, or stimulate the job market and increase business confidence, but risk losing control of inflation?

What Does This Mean for Investors?

While the Fed’s decision is being shaped by a delicate trade-off, equity markets have continued to rally. Embracing the prospect of rate cuts, US equity markets have recorded record highs. Rate cuts will be duly welcomed within high growth sectors with an abundance of investment, likely driving equity markets higher still. But the risk is that if the Fed misjudges — cutting too soon or too late — volatility could quickly return, particularly in consumer-facing sectors where earnings are vulnerable to spending cuts.

Yields have begun to stabilise at lower levels with the heightened expectations of an imminent cut, and this may lead to continued dollar weakness as cross-border currency flows gravitate towards higher yields.

The Noise

• Despite continued financial pressures, the US stock market remains resilient, having continued to post record highs. In contrast, European equities have held steady following the European Central Bank’s (ECB) decision to keep interest rates unchanged at 2.15%. The ECB last cut rates in June and with inflation hovering near the ECB’s 2% medium-term target, further rate cuts now appear unlikely in the near future.
• The so-called "September effect" – a term referring to the stock market’s historically weak performance during September – appears to have been avoided so far this year. Optimism around the Fed easing has outweighed seasonal caution for Investors.
• Bond Markets have seen varying movements this week, with the US 10 Year Treasury yields remaining near five-month lows – in expectation of imminent rate cuts. Whereas the yield on UK 10 Year Gilts has been choppier but risen gradually through the week following data showing that the UK economy stagnated in July, highlighting persistent inflationary pressures and fiscal uncertainty.
• Commodity markets have experienced a modest but positive week. Gold prices continued to climb, supported by geopolitical tensions and growing expectations of a Fed rate cut, which could weaken the US dollar. Oil prices remain relatively stable despite ongoing unrest in the Middle East and Eastern Europe, registering a slight increase over the week.