U.S. Job Growth Surprises, Sparking Cautious Market Optimism on Rate Cuts

Key Points Summary:

• Investor expectations for a December rate cut remain subdued following the release of uneven U.S. labor data.

• The September nonfarm payrolls report indicated robust job additions but heightened unemployment, signaling limited capacity for further Federal Reserve easing.

• Bank of America forecasts a stable labor market with modest unemployment growth and maintains that further rate cuts are unlikely under Chair Powell.

Investor expectations for a December interest rate cut have held near a recent low after the U.S. Labor Department released its delayed September nonfarm payrolls report. The report, the first since a government shutdown temporarily paused federal data, showed an increase of 119,000 jobs, far exceeding economists’ forecasts of 50,000. Despite this headline strength, the unemployment rate crept up to 4.4% from 4.3%, the highest level since October 2021, suggesting underlying economic softness.

This mixed economic signal has led to cautious market sentiment, with traders pricing in a low probability of a policy shift at the Federal Reserve's next meeting. However, optimism grew slightly on Friday after New York Fed President John Williams indicated he might support a rate cut. Williams observed that there remains "room for a further adjustment in the near term" to align monetary policy closer to neutral, injecting a dovish tone into market anticipations without significantly altering the overall rate trajectory.

Bank of America’s economist Shruti Mishra underscores the labor market as a pivotal factor influencing future Fed policies. She points out that the recent softness in job figures is largely due to disruptions in both labor supply and demand. While payroll growth slowed in recent months and the unemployment rate edged higher, she emphasizes that the jobless rate remains historically low. BofA projects a significant drop in labor supply, mainly due to stricter immigration policies. Mishra estimates that net immigration will decrease to approximately 380,000 over the next year, sharply down from an average of 2.1 million from 2020 to 2023. This trend could lead to a labor supply shock of around 90,000 workers per month compared to recent norms.

Given this projected constraint on worker availability, Mishra expects the breakeven job growth rate—necessary to maintain steady unemployment—to fall to around 20,000 jobs per month. This dynamic could stabilize the unemployment rate, even as job gains slow. Bank of America forecasts only a modest rise in unemployment, predicting it will peak around 4.5% early next year, which aligns with their view that the labor market will remain close to full employment.

Consequently, the bank concludes that the Federal Reserve has “limited scope for further rate cuts," noting that persistent inflation supports the stance that there will be no additional cuts while Jerome Powell remains chair.