The probability of a Fed rate cut in September now stands at 100% and the potential for an outsized 50bps cut before year-end has increased as concerns about labor market deterioration outweigh the threat of higher prices from tariffs.
August U.S. non-farm payrolls came in light for the month, posting a gain of only +22k versus the consensus for +75k. The report was highly anticipated, coming on the heels of a significant miss in July coupled with meaningful downward revisions, both of which contributed to the ouster of the head of the Bureau of Labor Statistics, Dr. Erika McEntarfer, by President Donald Trump. Revisions were once again negative in aggregate, with the June print revised downward by -27k, resulting in a -13k print, while July’s number benefited from a positive revision of +6k. These changes, combined with today’s lackluster report, pushed the three-month trailing average for payroll gains to only +29k, reminiscent of 2020 levels.
Looking through the drivers of this month’s gains, health care and social assistance hiring combined for +47k, well off the prior month’s total, while leisure and hospitality rebounded to post a +38k gain. Retail was also higher by +11k. Federal government employment continues to decline, down another -15k in the month of August and off by -97k from its peak in January. Mining, manufacturing, and wholesale trade all posted losses for the month as well. As expected, the unemployment rate rose to 4.3% driven in part by a welcome increase in the participation rate from 62.2% to 62.3%. The number of employed persons also rose by +288k in the month, as the labor force grew by +436k. Average hourly wages also moved higher by +0.3% month-over-month and +3.7% year-over-year, helping to dampen tariff impacts for consumers; wages were higher even as hours worked declined slightly.
We believe that two takeaways from this release are worth watching in the coming months. First, the U.S. economy continues to experience job losses in goods producing industries. The intent of tariffs as understood by most investors is two-fold: to increase revenue and to encourage a more level playing field for U.S. goods which would in turn incentivize an increase in goods production in the U.S. In August, goods producing jobs in the U.S. were down by -25k in aggregate, and more specifically in manufacturing, -12k jobs were lost last month, and -78k have been lost this year. While we believe there are tailwinds in the form of tax incentives, a lower interest rate environment, and policy changes for companies to increase capital expenditure and shift more production to the U.S., there has been little to show for it in the labor market up to this point.
When looking more closely at the data, the second is the trend lower in hiring in health care, social assistance, and the U.S. government. In the post-pandemic period, these three industries accounted for the bulk of the jobs added. Should a deceleration in job gains in these sectors continue, private payrolls in areas such as financial services, technology, and the goods producing sectors mentioned above would need to accelerate to fill the gap. With the potential for productivity benefits derived from AI on the horizon, perhaps translating to the slow pace of entry level hiring in professional services, it might prove difficult to get that needed boost.
Translating the data into likely action, the probability of a Fed cut at the September meeting now stands at 100%. In addition, an outsized cut of 50 basis points between now and the end of the year has increased as well, as concerns about a more meaningful deterioration in the labor market are more than offsetting the threat of higher prices due to tariffs – particular as the fate of the Liberation Day reciprocal tariffs hang in the judicial balance. Equity markets appear to be discounting the risk of a broader economic slowdown, instead moving higher on the prospects for lower interest rates; small caps and growth are both benefiting in the early session. Treasury yields are lower across the curve, shifting in parallel with the expectations for a decline in the front end.
While we acknowledge that the risks appear to be somewhat less balanced after the last two non-farm payrolls reports, we remain of the view that the Fed will cut twice this year and will likely continue to cut rates for a cumulative 100 basis points through the first half of 2026. For fixed income investors, we remain focused on repositioning cash into more attractive opportunities and encourage a thoughtful approach to both duration and credit quality in this dynamic environment. Within equities, we believe that a rotation is likely to continue through the remainder of 2026 and advise allocations in small and non-US equities to complement existing U.S. large cap exposure.
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