In the Fed’s battle between fighting inflation and curbing unemployment, the latter held out on Wednesday, but could have an advantage heading into 2026 if labor market weakness becomes more apparent through an apparent overcount of payrolls.
In the short term, concerns over the employment situation meant that the central bank voted to cut the central bank’s key interest rate by a quarter of a percentage point, albeit by a 9-3 margin. There are signs that if the labor market continues to be weak, policymakers will be inclined to make further cuts.
Chairman Jerome Powell mentioned several times during Wednesday’s press conference that job growth in recent months was likely negative, a condition for making the case for easing monetary policy.
Chairman Powell said, “The labor market continues to cool down gradually.” “Both household surveys and business surveys show that demand and supply of workers are decreasing. So I think we can say that the labor market is gradually cooling down a little bit more than we thought.”
At issue are the Bureau of Labor Statistics’ monthly estimates of how the labor market is affected by business closures and openings. This estimation, known as the birth-death model, estimates the jobs gained through openings and the jobs lost through closures.
Powell said the model probably overestimated about 60,000 jobs a month since April. Employment growth over this period averaged just under 40,000 jobs, which, even if overstated, equates to a payroll loss of about 20,000 jobs per month.
Powell calls for caution
The chair said the discrepancy was “akin to systematic overcounting” and that the employment growth figures were likely to be significantly revised.
In September, the BLS released preliminary benchmark estimates that found employment growth for the 12 months ending March 2025 was overstated by 911,000 jobs. The final tally is expected to be announced in February.
“In a world where job creation is negative, I think we need to monitor that closely and make sure that our policies don’t drag down job creation,” Powell said.
As the Fed heads into 2026, balancing support for the labor market with controlling inflation will be central to its policy decisions.
At this week’s Federal Open Market Committee, officials expressed wide disagreement over where interest rates should go. According to a dot plot of individual predictions, 6 out of 19 participants opposed the current rate cut, 2 out of 12 who voted opposed it, and 7 said there was no need for a rate cut next year.
However, some believe there is room for at least some additional easing. This would signal further concerns about the labor market, even as inflation remains above the Fed’s 2% target. But Powell said much of the inflation overshoot was due to President Donald Trump’s tariffs, and that the impact is expected to wane as the months go by.
Market expects further reductions
If inflation subsides and the view that the labor market is weak remains, we would expect the Fed to lean toward an accommodative bias, especially with Mr. Powell stepping down as chairman in May.
“With the Fed’s most influential members focused on the unemployment rate, we believe the path to further rate cuts remains open as long as labor demand weakens and unemployment rises, despite vocal opposition from hawks,” Natixis economist Christopher Hodge said in a note.
“With unemployment expected to rise through the first quarter of 2026, we believe the Fed will continue to cut rates to prevent further weakness in the labor market,” Hodge said. “We believe a January rate cut is more likely.”
Stocks rose on Wednesday and Thursday on hopes that the FOMC’s comments were not as hawkish as feared.
Still, futures market pricing indicates the next rate cut won’t happen until at least April. Traders are also betting on two rate cuts in 2026, but CME Group’s FedWatch indicator puts the probability of three rate cuts at 41%, which is more aggressive than the one rate cut indicated by the dotplot.
