Case for more Fed rate cuts could rest on ‘systematic overcount’ of jobs
In the Federal Reserve’s struggle between fighting inflation and limiting unemployment, the latter took advantage Wednesday and could also gain an advantage heading into 2026 if labor market weakness becomes more pronounced due to an apparent overcount of jobs.
In the short term, concerns about the employment situation meant a vote to cut the central bank’s key interest rate by a quarter point, albeit by a 9-to-3 margin. Going forward, there are signs that policymakers will be inclined to make further cuts if the labor market remains soft.
In Wednesday’s press conference, Chairman Jerome Powell noted several times that there has likely been negative employment growth in recent months, which would require easier monetary policy.
“The gradual cooling in the labor market has continued,” Powell said. “Surveys of households and businesses show that the supply and demand for workers is decreasing. Therefore, we can say that the labor market continues to cool slowly, even a little more slowly than we thought.”
At issue is the Bureau of Labor Statistics’ monthly estimate of how the labor market is affected by business closures and openings. Known as the birth-death model, the forecast provides an estimate of the jobs gained by openings and lost by closings.
Powell said the model has probably overstated things by about 60,000 per month since April. Given that employment growth averaged around 40,000 during that period, an exaggeration of that size would equate to a payroll loss of approximately 20,000 per month.
Powell calls for caution
The president called the discrepancy a “systematic overcount” and will likely see major revisions to job growth figures.
In September, the BLS released a preliminary benchmark estimate that job growth was overstated by 911,000 jobs in the 12-month period through March 2025. The final count is scheduled for February.
“In a world where job creation is negative, I think we need to monitor that situation very carefully and be in a position to not suppress job creation with our policy,” Powell said.
Balancing the Fed’s support for the labor market by keeping inflation under control as we enter 2026 will be at the center of policymaking.
At this week’s Federal Open Market Committee meeting, officials expressed broad disagreement on where rates should go. Six of 19 respondents said they opposed the latest rate cut – two of whom were among 12 who voted – and seven said they did not see the need for any cuts next year, based on a “dot plot” of individual expectations.
On the other side, there are those who think there is at least room for more relaxation. This points to larger concerns about the labor market, even though inflation remains above the Fed’s 2% target. But Powell said most of the inflation overshoot is due to President Donald Trump’s taxes, and the impact is expected to diminish as the months go by.
Market sees more disruption
If there is a view that inflation is falling and the labor market is stumbling, the Fed can be expected to shift towards easing, especially after Powell leaves his post as chairman in May.
“With the Fed’s most influential members closely monitoring the unemployment rate, as long as labor demand decreases and [the] “If the unemployment rate rises, it will clear the way for additional cuts despite vocal opposition from hawks,” Natixis economist Christopher Hodge said in a note.
“As we see the unemployment rate rising through the first quarter of 2026, we think the Fed will continue to cut to stem further softening in the job market,” Hodge added, adding, “We think a cut in January is more likely than not.”
Stocks rose Wednesday and Thursday on hopes that the FOMC’s rhetoric was not as hawkish as feared.
Still, futures market pricing suggests the next outage won’t occur until at least April. Investors are also betting on two cuts in 2026, which is more aggressive than the single move shown on the dot chart, with even the odds of three moves being 41%, according to CME Group’s report. FedWatch measurement.
