Cooling labor market signals rate cuts coming: Economist

The US labor market has seen an uptick in company layoff announcements, with Macy’s (M), Wayfair (W), and Google (GOOG, GOOGL) recently set to cut jobs. With the labor market cooling, could this signal early March interest rate cuts which the market remains hopeful for?

Bank of America Chief US Economist Michael Gapen joins Yahoo Finance Live to discuss the factors that could lead to the Federal Reserve cutting rates soon.

Gapen notes that the labor market is significantly more impactful now to a Fed decision than in previous months: “The quicker the labor market cools down, the more Fed cuts should be coming."

A soft landing scenario is expected as Gapen insists that “the Fed has a stronger vested interest in achieving that soft landing than at any point during the recovery," and doubts that the Fed is reliant on the unemployment rate needing to reach 5% or above.

In the case that the Fed does not cut rates in March, Gapen believes that a June cycle "would not make much of a difference."

For more expert insight and the latest market action, click here to watch this full episode of Yahoo Finance Live.

Editor's note: This article was written by Eyek Ntekim

Video Transcript

- We want to bring in Michael Gapen. He is Bank of America's Chief US Economist. Michael, it's great to talk to you again. So let's start with the Fed cuts, the timing, and exactly how the labor market, the recent developments that we've seen, how you see that playing into the decision here that we could be getting from the central bank over the coming months. I guess, do you think a March-rate cut is still on the table?

MICHAEL GAPEN: We do. We have four cuts this year. So 100 basis points and cuts in 2024. But the cutting cycle starting in March. And I think you bring up a good point that the labor market is more important in the Fed's thinking than it was, say 12 to 18 months ago when the Fed was willing to endure, in their words, some pain in the labor market in order to help bring inflation down to low and stable levels.

But as we moved across 2023 and into 2024, the Fed is seeing actual data that says, hey, we can grow at a modest rate while still seeing inflation come down. So in December, the Fed admitted their reaction function has changed a bit, meaning the more the labor market softens, the more the Fed will be inclined to move to rate cuts and potentially move faster. So yes, the quicker the labor market cools down, the more Fed cuts should be coming.

- Is it is it more about seeing that unemployment rate tick higher to that above 4% and actually 5% forecast that some economists have put out there, or is it, on the other side, if the Fed is able to still have a strong employment situation but see inflation continue to cool and get to that two handle but 2% target that they've put forward that it's fine if the labor market doesn't deteriorate to the expectation that some economists have put out there?

MICHAEL GAPEN: That's right. I would say the latter composition of your remarks there would be consistent with the soft landing outlook. In other words, I think the Fed has a stronger vested interest in achieving that soft landing than at any point during the recovery. So as long-- the supply side of the economy has rebounded. Global supply chains have eased. But more importantly, all the discussion we had 18 months ago about labor shortages has gone away. The participation rate has rebounded strongly. It's allowed the services side of the economy to expand as rapidly as it has while still bringing down wage pressures.

So I think the Fed's of the mind and saying, we don't need to step on the labor market too hard, and they would want to lean against any expectation that the unemployment rate needs to rise to 5% or above. Some backup, I think, is warranted, and they would be OK with it. But something in the low fours is probably what they're thinking. So anything beyond that, again, would lead them in the direction of rate cuts to underpin activity and prevent the labor market from weakening more.

- Michael, if we don't see the Fed cut rates in March, I know you are expecting that, but if we don't see the Fed follow through and do that, what does that then do for your prediction or your expectation of a recession? How much does that raise the odds that we could see some sort of hard landing for the economy?

MICHAEL GAPEN: Well, I think if they don't go-- I think they're close. I think it'll be close enough in March, such that even if they don't go, I think all of us would say, feels like conditions will be right for them to start the rate cut cycle around the middle of the year. So I think more likely people like us in the March camp would say, OK, they're close just not there. They need a little more evidence. So let's think June.

So I doubt a two to three months difference in the timing of a easing cycle a normalization cycle would make that much of a difference. But the longer the Fed would delay, the more I would get concerned because markets have priced in a lot of easing. So if the Fed doesn't validate, some of that financial conditions could tighten, and then perhaps you would risk a sharper slowdown in the labor market.