What Will the January Jobs Report Mean for Fed Rate Cuts?

The strength of the economy is a key variable in expectations around when the Federal Reserve will cut interest rates. Forecasts for the January jobs report anticipate more evidence of the labor market remaining solid but growing at a sustainable pace.

Friday’s jobs data will come in the wake of the Fed’s January meeting which concluded Wednesday, where the policy-setting Federal Open Market Committee opted to hold rates at their current target range.

Investors have been eagerly awaiting signals that the economy has achieved a rare soft landing and escaped major damage in the wake of one of the most aggressive monetary tightening cycles in the Fed’s history. “Inflation has eased from its highs without a significant increase in unemployment,” Fed Chair Jerome Powell said Wednesday. “That’s very good news.”

Despite that progress, Powell warned markets that the central bank likely won’t be ready to ease policy until it has greater confidence that inflation is moving sustainably toward its 2% target.

Forecasts for the January Jobs Report

The U.S. economy is forecast to have added 176,500 new jobs in January, according to FactSet’s consensus estimates. But lags in the inner workings of the government’s employment calculations could mean a surprisingly high number, according to some strategists.

“We’re probably going to get another strong jobs number,” says Alejandra Grindal, chief economist at Ned Davis Research. That’s true even though payroll growth is not as robust as it was in 2023. “We’re definitely getting to more normal levels,” she adds.

After December’s increase in hiring topped forecasts, January’s data could give the Fed (and investors) more clarity into the potential timing for rate cuts.

“The bottom line is that the report should continue to point to a cooling labor market, but not one that is showing significant signs of weakness,” Bank of America analysts (who are predicting gains of 175,000 jobs) wrote in a research note Friday. That should be music to investors’ ears.

January Jobs Report Consensus Estimates

• Nonfarm payroll employment is forecast to rise 176,500 vs. the 216,000 increase in December, according to FactSet.
• The unemployment rate is forecast to rise to 3.8% from 3.7% in December.
• Hourly earnings are predicted to rise 0.3% on a monthly basis, down from 0.4% in December.

Bank of America’s analysts predict job gains will be driven by gains in the government, healthcare, education, and leisure and hospitality sectors. They note that hiring in other areas, including the services and goods sectors, has likely slowed.

Bill Adams, chief economist for Comerica Bank, says that the Fed’s recent rate hikes have weighed on interest-rate-sensitive sectors like real estate. “That’s affecting the composition of job growth,” he says. He will also be watching for a slowdown in sectors with hourly workers that could have been affected by January’s cold weather, like hospitality and retail.

Changing Seasonal Patterns Could Lead to Upside Surprise

Some Wall Street analysts are expecting significantly stronger growth than others in January, thanks to changes in seasonal layoff patterns. The statistical models the government uses to smooth out seasonal patterns in hiring are set to adjust for post-holiday-season layoffs. But that pattern may not be as strong as in years past.

JPMorgan chief U.S. economist Michael Feroli is anticipating job gains of 225,000 in January. “The prior seasonal pattern of large layoffs in January seems to have diminished in the post-pandemic years—a regularity that the seasonal adjustment routines may not have fully learned about yet,” he wrote in a note to clients last week. That lack of softening could delay the Fed’s confidence about rate cuts, he added.

Analysts from Goldman Sachs are expecting even stronger growth of 250,000 for the month, again thanks to significantly lower seasonal layoffs this year.

Wage Growth Remains Steady

“I think we’ll see further solid wage increases in January,” Adams says. He expects wage growth of 4.1% on an annual basis, which is “a solid notch faster than in the pre-pandemic period but down from 2021 and 2022, when the labor market was running very hot.”

Even though wage growth has slowed somewhat, inflation has slowed faster. The result, according to Grindal, is that “real wage growth is quite positive and has generally been accelerating.” That’s been good for consumers, and in turn good for the labor market. “As long as consumers keep spending, then the economy does okay,” she says. “And they’re going to keep spending if they keep their jobs.”

When Will the Fed Cut Rates?

At its January meeting this week, the Fed kept its target range for interest rates steady at 5.25%-5.50%, as it was near-universally expected to. Now market watchers are turning their full attention to March. Bond traders are pricing in a roughly 45% chance of a rate cut at that meeting, according to the CME FedWatch Tool—down from more than 70% a month ago.

Adams estimates that the central bank will want to see the unemployment rate hold steady somewhere between 3.5% and 4.0%, which would indicate a strong labor market but would not be out of line with other historical periods of healthy inflation. So far the labor market appears to be hitting that target, with rate hikes slowing the pace of hiring to more sustainable levels.

“The Fed would be concerned to see employment fall, and the Fed would also be concerned to see job growth significantly accelerate,” Adams says. “If the economy runs too hot, that could fuel the resurgence of inflation pressures.” Powell noted Wednesday that an unexpected weakness in the labor market could prompt the Fed to cut sooner than expected.

What’s ahead in March remains to be seen. Some market watchers believe cuts are more likely to come later in the year. There will be more inflation and employment numbers released ahead of the next meeting. “We need to see more evidence that confirms what we think we’re seeing and that gives us confidence that we’re on a sustainable path down to 2% inflation,” Powell said Wednesday.