September 4, 2025

QuickTakes

Flocking Doves Tomorrow?

Stock prices rose again today as the 10-year bond yield fell. Investors anticipate that tomorrow's employment report for August will be weak. If so, then it is a sure bet that the FOMC's majority will turn dovish and will vote to cut the federal funds rate on September 17. Indeed, the odds are up to 99.4%, according to the CME FedWatch Tool. Stock investors must be thinking that if the report is better than expected, that's bullish for earnings. So another postponement in rate cutting by the Fed is no problem for the stock market. If the jobs report is weak, then the FOMC will deliver a Fed Put in two weeks. So the consensus is that there is no downside, only upside.

Our main objection to a rate cut is that it will probably fuel a meltup in the stock market, especially if most of the data up ahead confirm the resilience of the economy. Indeed, real GDP is on track to increase 3.0% during Q3 after rising 3.3% in Q2, according to the Atlanta Fed's GDPNow (chart). The Citigroup Economic Surprise Index is solidly in positive territory at 25.8 today.

The above explains why both stock and bond prices rallied today following the release of August's ADP report, which showed private payrolls rising by just 54,000 during the month (chart).

On the other hand, the Challenger report today showed a slight increase in layoffs during August (chart). Also remaining low today was the initial unemployment claims series from last week, confirming that layoffs remain subdued. The latest reading on continuing unemployment claims suggests that the duration of unemployment might have stopped increasing recently.

Today's August survey of non-manufacturing purchasing managers showed a solid increase in the NM-PMI to 52.0 (chart). However, the M-PMI remains below 50.0.

The employment components of both the NM-PMI and M-PMI were weak in August, at 46.5 and 43.8, respectively (chart). They've been relatively weak for a while, despite solid employment reports, until recently.

Now the good news: Q2's productivity growth rate was revised up sharply from 2.4% (saar) to 3.3% as output rose 4.4% (up from a revised 3.7%) and hours worked rose 1.1% (down from 1.3%) (chart). This confirms our view that the problem in the labor market is a shortage of labor, more than insufficient demand. Employers are solving this problem by boosting productivity and real wages. Hourly compensation rose 4.3% (saar) and 2.6% during Q2 in nominal and real terms.

The underlying inflation rate in the labor market, i.e., unit labor costs, rose just 1.0% q/q and 2.5% y/y during Q2 (chart).

This is all consistent with our Roaring 2020s scenario, which doesn't require the Fed to cut interest rates. On the contrary, our concern is that lowering interest rates will lead to financial instability, including a meltup/meltdown in the stock market. Solid productivity-led growth in real GDP implies that interest rates are currently just fine where they are.

If the employment report is weak tomorrow, the S&P 500 could rally to a new record high, driven by expectations of a Fed Put on September 17. That might boost the bull-bear ratios to levels that could set the market up for a pullback, perhaps after the Fed pulls the trigger (chart).

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