Evidence is mounting that a weakening labor market could dampen the optimistic economic outlook for the U.S. economy this year, while also paving the way for further interest rate cuts. There was a lot of employment-related data released this week, and none of it was positive. Private employment was nearly flat in January, with a net gain of just 22,000 jobs, according to ADP. The number of job openings has fallen to the lowest level since September 2020, dropping by nearly 1 million jobs in just two months. With the U.S. economy still mired in financial crisis, the number of planned layoffs and payrolls at large companies in January was the lowest in the month since 2009. Employment indicators for both the service sector and manufacturing showed that employment was stagnant. Taken together, these data support the concerns of some Federal Reserve policymakers. If current conditions continue, the outlook for the labor market is remote and further policy support (in the form of interest rate cuts) may be needed. “This is far from a healthy labor market,” Fed Director Christopher Waller said in a statement, explaining his support for rate cuts at the January meeting. “At multiple outreach meetings, I have heard that layoffs are planned for 2026. This indicates to me that there is considerable doubt about future job growth and suggests that a significant deterioration in the labor market is a significant risk. Although most markets expect the Fed to keep interest rates on hold until June, many Wall Street economists believe it is unrealistic for policymakers to suggest that there will be only one rate cut this year, in December. Mark Zandi, chief economist at Moody’s Analytics, is among a large group that expects up to three actions this year as the Fed is forced to become more aggressive in protecting the full employment aspect of its dual mandate. “The weak labor market is the main threat to the economy this year,” he said. “It’s very fragile. We’re not creating jobs.” To be sure, none of the data is dire. New jobless claims rose to their highest level in nearly two months last week, a move largely due to the vicious winter storm that affected large swaths of the country. Beyond that, despite some recent high-profile announcements from major employers like UPS and Amazon, there isn’t much evidence of widespread layoffs. But labor market weakness complicates matters, as inflation remains well above the Fed’s 2% bogey. “My expectation is that the unemployment rate will continue to trend upward,” said Christopher Hodge, chief U.S. economist at Natixis CIB. “This is still a Fed that prioritizes the labor market. We still haven’t hit our inflation target for 57 consecutive months. Everyone, including me, is planning for more rate cuts.” Both Mr. Hodge and Mr. Zandi expect the Fed to cut rates three times this year. Futures traders are still pricing in two, but the probability of a third is nearly 40%, according to CME Group’s FedWatch. Market Questions Another important factor is that the stock market has been volatile this year, despite Friday’s massive rally. A study closely monitored by the University of Michigan found that stock market prices are helping to keep consumer sentiment on the lower end, but otherwise only a few points above their all-time lows. The February survey update released on Friday showed a gradual improvement, largely thanks to asset holders. “Sentiment for consumers with the largest stock portfolios soared, but stagnated and remained at dismal levels for consumers with no stocks,” said research director Joan Hsu. According to the St. Louis Fed, gains and losses in the stock market are skewed towards the upper income brackets, with the top 1% of income earners owning 36% of financial assets. Consumers drive more than two-thirds of all economic activity, and most spending comes from high-income consumers, so it’s important to keep that sentiment high. “The wealth effect in the stock market occurs over a period of time, so it’s more indirect,” Zandi said. “This should also be at the top of the list, especially in a context where savings rates are very low. Falling stock prices are stimulating wealthy households to spend more of their incomes… If stock markets falter, that would mean a significant decline in consumer spending.” However, some easing is expected in the future, which could change the equation further. Stimulus measures related to the “One Big Beautiful” spending bill passed last year are expected to lead to increased income tax refunds to help individuals, along with regulatory relief and expense provisions for businesses. With all this in mind, Hodge, the Natixis economist, thinks the economy will still grow at a pace of 2.2% next year, even with the help of a Fed rate cut. Kevin Warsh, who will be named Fed chairman when Jerome Powell resigns in May, is expected to push for lower interest rates and shrink the central bank’s footprint in the economy. “As long as unemployment continues to rise, the Fed will continue to provide relief,” Hodge said. “Now, that’s what I think the Fed is going to do. I don’t think they should cut rates at all.”
