Market expectations for rate cuts by the U.S. Federal Reserve (Fed) have strengthened following Fed Chair Jerome Powell's speech at the Jackson Hole symposium.
Fed's Governor Christopher Waller on Thursday also said he wants to start cutting U.S. interest rates this month and "fully expects" more rate cuts to follow to bring the policy rate closer to a neutral setting.
However, the start of the legal saga following the move of President Donald Trump to fire Fed's Governor Lisa Cook and this week's labor market report will test the central bank and the size of a potential cut it might deliver later this month.
The federal funds rate target range is currently set at 4.25% to 4.50% range with inflation also running close to the Fed's 2% goal.
"Upside risks to inflation had diminished," Powell said in relation to current economic conditions at Jackson Hole. Still, he cited that the unemployment rate had increased by almost a full percentage point, marking a development that he said, historically, has not occurred outside of recessions.
With a fresh labor market report coming late this week, Fed policymakers will get new insights into the economy's health and the report will also test investors' confidence that interest rate cuts are indeed coming soon.
Last month's release of surprisingly weak U.S. payrolls data raised expectations that the Federal Reserve will start cutting rates again at its next meeting in September, as the central bank moves to support the labor market despite inflation worries.
A soft August employment report on Friday could raise concerns about a slowing economy, but it also might lead the market to price in more aggressive cuts, said Jack Janasiewicz, lead portfolio strategist at Natixis Investment Managers Solutions.
"Lower rates probably trump a modestly slowing labor market, and that probably puts a floor underneath the economy and ... the stock market," he said.
U.S. equities have charged higher since hitting their lows for the year in April. Investors have shaken off concerns that Trump's tariffs would send the economy into a recession, while a wide swath of tech and other stocks have benefited from optimism about the business potential of artificial intelligence.
Stock indexes fell on Friday, as declines in AI-related names added to recent shakiness in tech stocks, with earnings reports from heavyweight chipmaker Broadcom due on Thursday. Still, the benchmark S&P 500 ended the traditionally challenging month of August up 1.9%, pushing its year-to-date gain up to about 10%, near record-high levels.
Yet, markets remain in a historically treacherous patch on the calendar. Over the past 35 years, September has ranked as the worst-performing month of the year for the S&P 500, with an average decline of 0.8% during that period, according to the Stock Trader's Almanac. The index has fallen 18 of 35 times in September, the only month to have been down more than up in that period, according to the Almanac.
The jobs report is September's first major economic release. Employment in August is expected to have climbed by 75,000 jobs, according to a Reuters poll. In the prior month's report, nonfarm payrolls grew by 73,000, a surprisingly weak number compounded by sharp downward revisions to growth in the prior two months.
Alex Grassino, global chief economist and head of macro strategy at Manulife Investment Management, said he expects components of the jobs report, such as the unemployment rate and hourly earnings, "to point to basically the same message, which is the U.S. labor market has cooled."
The weak July report raised market expectations that the Fed would cut rates at its next meeting in September, bets that firmed after Powell recently said job market risks were rising.
Fed funds futures as of Friday suggested an 89% chance the central bank will reduce rates by 25 basis points at its Sept. 16-17 meeting, LSEG data showed.
"It would take very broad-based strength in the report in order to get the Fed to rethink the idea of moving rates lower," Drew Matus, chief market strategist at MetLife Investment Management, said, adding the odds of such a report are "pretty low."
"We could see an OK report, and an OK report isn't going to dissuade the Fed from cutting," Matus said.
While a September cut may be close to locked in, the jobs data also could sway expectations about the amount of easing in the months ahead. Fed funds futures suggest about 55 basis points, or just over two standard cuts, are expected by December.
Other developments at the Fed will also be in focus for the market in the coming week, after Trump moved to fire Fed Governor Cook as he seeks to reshape the central bank's board. Cook filed a lawsuit on Thursday, claiming Trump has no power to remove her from office.
The controversy has reignited concerns over the Fed's credibility and its ability to conduct monetary policy free of political pressure, after Trump for months railed against the Fed and Powell specifically for not lowering rates to the extent he wants.
While the situation has ramped up speculation in capital markets around Fed independence, those risks are probably appropriately priced in, for now, Grassino said.
"A lot of things that traditional market participants would have taken as a given are being questioned," he said. "So as they are coming up, you are widening out the tail risks that you could potentially see."
