In the context of already very tight policies, a sharp rise in the unemployment rate may prompt the Federal Reserve to take more aggressive interest rate cuts. Jerome Powell, the Federal Reserve Chairman, mentioned in his speech at Jackson Hole that avoiding such a situation is the Fed's goal. If the unemployment rate rises sharply, rate cuts exceeding market expectations may be needed to restore policy rates to stimulating levels.
The market was surprised by a 0.2 percentage point jump in the unemployment rate to 4.3% in July, which is similar to conditions during recession periods. The underutilization rate rose to 7.8%, indicating that more workers couldn't find ideal working hours, which put pressure on risk assets. The nonfarm payroll report for August faces high risks; although the market expects the unemployment rate to fall back to 4.2%, early signs show this may be difficult to achieve without a decline in the labor force participation rate.
Signs of a hiring slowdown and an increase in layoffs are significant. The ADP report shows that private sector job growth in August was only 99,000, below the expected 145,000, marking the lowest since January 2021. The number of layoffs reached a five-month high, suggesting that the unemployment rate may continue to rise, increasing the risk of aggressive rate cuts by the Federal Reserve.
The market is divided on the expected rate cut by the Federal Reserve at its September meeting, with the likelihood of a 25 basis point cut almost equal to that of a 50 basis point cut. If the unemployment rate continues to rise significantly, the Fed may need to cut rates by more than 50 basis points. Even if the next eight FOMC meetings are expected to cut rates by 200 basis points, rates may still remain in a restrictive range.
In the event that the Federal Reserve is forced to make significant rate cuts, the dollar may weaken against the yen, Swiss franc, and euro but strengthen against emerging market currencies. The US Dollar Index (DXY) continues its downward trend and could drop to the low of 100.52 touched in July. If this level is breached, 99.60 will become the next level to watch.
