Jobs report will sway Fed’s decision on size of rate cut

Federal Reserve officials have signaled in recent weeks that a rate reduction is all but certain at their meeting in mid-September. Officials are satisfied that inflation has resumed a slowdown, after a surprising setback at the start of the year delayed their plans to cut. But some are more nervous now about keeping interest rates at a two-decade high because the labor market might be slowing too much.

As a result, the debate at the Fed’s Sept. 17-18 meeting centers on whether to begin lowering rates by a more-traditional, quarter-percentage point or to pre-empt undesired job-market weakness with a larger, half-point reduction.

The report Friday on hiring and employment in August will be pivotal in shaping that decision. A decent jobs report might lead officials to kick off a likely sequence of rate cuts with a quarter-point reduction. A larger cut looms if hiring is soft or the unemployment rate jumps—as in July.

Friday also happens to be the last day Fed officials can communicate publicly before a self-imposed premeeting quiet period begins. New York Fed President John Williams and Fed governor Christopher Waller are set to speak Friday morning after the jobs report is published, providing a final opportunity to set expectations for the coming meeting.

The tactical considerations at play for the Fed’s next meeting leave officials in a precarious position. With the economy and inflation now slowing as they anticipated at the beginning of this year, there is a stronger case to move interest rates from their current setting at around 5.3% to somewhere closer to 4.5%. Indeed, economists and investors expect the Fed to cut rates at each of its next several meetings.

But the size of the first move will be heavily scrutinized because of what it says about the economic outlook and the risks around that outlook. Officials’ justification for either a 0.25-point or a 0.5-point reduction will matter greatly.

Without signs that weaker hiring in July continued through August, some Fed officials are likely to resist a larger, half-point cut. But a few officials who were open to cutting rates at the Fed’s most recent meeting at the end of July could support a larger, half-point move in September, and they would enjoy broader support if Friday’s monthly employment surveys show another jump in the unemployment rate and a sharper slowdown in job growth.

When Fed officials last met in July, the most-recent jobs data showed an unemployment rate of 4.1%. The reading one month ago of 4.3% continues a climb from a low of 3.4% in April 2023. Because the recent jump was driven in part by workers who were put on a temporary rather than permanent layoff, several officials have pointed to reasons to think the unemployment rate could decrease in August.

The July report “was not a sign of weakening," said San Francisco Fed President Mary Daly, in an interview with a Wall Street Journal podcast recorded Tuesday. If those temporary factors “dissipate, then I’d say we’re still in the healthy position," she said.

At the same time, officials don’t want to wait to see weakness, because by then it might be harder to stop a more serious slowdown from unfolding. “If you’re in an inflection point in the economy, by the time you get the published data, you are too late. So you can’t rely solely on this published data because it’s backward-looking," said Daly.

Fed Chair Jerome Powell signaled at a news conference July 31 that a half-point cut was “not something we’re thinking about right now." But that was before the July employment report was released two days later, fanning fears of a bigger chill hitting the labor market. A range of employment surveys suggest the labor market is now less tight than it was in 2018 and 2019, before the pandemic, though economic activity has been steady.

In a highly anticipated speech two weeks ago, Powell pivoted more crisply and said he was now focused on preventing a further slowdown in the job market. He said recent cooling had been “unmistakable" and that further weakening was “unwelcome." Many interpreted those comments as leaving all options on the table for the Fed’s next meeting.

Other Fed officials have echoed that language in recent days. “Any additional slowing would be unwelcomed, and we don’t want to wait until we see it, because then it’s too late," said Daly.

The Fed is a consensus-oriented institution that tends to move gradually when the economic outlook is uncertain. As a result, it often prefers to raise or cut rates in quarter-point increments. The last time the Fed switched from raising rates to cutting them, in 2019, it began by lowering rates by a quarter-point. It did the same thing during growth scares in 1995 and 1998.

“The mindset I like on this is, ‘Test and learn,’" said Richmond Fed President Tom Barkin in an interview last month. “Testing and learning while you go is a much better way to go."

Larger cuts of a half-percentage-point, or 50 basis points, typically happen in urgent situations, such as the onset of the Covid-19 pandemic in March 2020; after credit markets began seizing up in September 2007; and after manufacturing activity and the labor market appeared to be cooling notably in early 2001.

“There’s an awfully strong argument to go ahead and do 50," said Diane Swonk, chief economist at KPMG. “The labor market is not in recession, but the ice is thinning. You don’t want to have it slip away inadvertently. Even if we get a good number on Friday, labor-market slack is growing."

Write to Nick Timiraos at Nick.Timiraos@wsj.com