Does the latest U.S. jobs report make a rate cut more likely?

On the latest edition of Market Week in Review, Quantitative Investment Strategist Abraham Robison and Rob Cittadini, director, Americas institutional, discussed May’s U.S. employment report, the latest headlines around trade and the recent rally in equity markets.

Lackluster May jobs report may help pull Fed from the sidelines

The U.S. economy added just 75,000 jobs in May, Robison said—far below the consensus estimate of 160,000. The modest addition was even short of the replacement rate—the estimated number of new jobs needed each month to keep up with population growth—which stands at 100,000, he stated. “May’s jobs number is even more disappointing in light of the fact that this data was collected prior to the recent trade-war escalation,” Robison added.

The U.S. Federal Reserve (the Fed) has already been grappling with economic uncertainty due to trade policy and a slump in capital-expenditure spending, he noted. “This employment report only adds to the growing list of downside risks for the central bank to think about,” Robison said, adding that this likely increases the probability of a Fed rate cut.

Trade-war fallout: The impacts on business spending

Trade rhetoric dominated the headlines again this week, Robison noted, as U.S. President Donald Trump doubled down on his threat to potentially impose a 5% import tariff on all Mexican goods as soon as June 10. “This plan is meeting a lot of resistance in the U.S. Congress,” he stated, “so it’s increasingly difficult to assess when these tariffs may be enacted, let alone how long they may stay in place.” 

On the China front of the trade war, Robison noted that the U.S. currently has imposed a 25% tariff on $250 billion worth of Chinese goods. “The U.S. administration has also threatened to slap tariffs on an additional $300 billion worth of Chinese goods, which would mean all imports from China would face a tariff,” he added.

China is America’s largest trading partner, with Mexico coming in second, Robison said. “Together, the two nations account for roughly one-fifth of all imports to the U.S.,” he stated, “and this has led to heightened uncertainty in business spending as the trade war continues.” As an example, he noted that one company surveyed in the most recent Institute for Supply Management (ISM) manufacturing report stated that it would move its production out of China, as a result of the U.S. tariffs. “The company stated it would shift production efforts to Mexico—but this was before the U.S. threatened to impose tariffs on all Mexican imports,” he said.

In short, the trade war is creating a disincentive for companies to spend, Robison explained, thereby lowering investor sentiment. This, in turn, has led to an inverted U.S. Treasury yield curve, with longer-term yields falling below shorter-term yields. “This makes banks less likely to lend, leading to tighter spending among consumers and businesses alike—which can act as a drag on the economy,” he concluded.

Markets rally on hopes of rate cut

Despite the generally negative headlines, Robison said that equity markets have been trending upward over the past week. “It appears that the surge in equities is being driven by the increasing probability of a Fed rate cut—due in large part to trade policy and slowing economic growth,” he said. Robison noted that, according to CME Group, futures traders see a 95% chance of a reduction in interest rates by the end of September. “The market is probably pricing this in, fueling the recent rally,” he concluded.