By Gordon Gottsegen
Labor-market performance will likely influence the Fed’s rate-cutting cycle
Both investors and the Fed will be watching the performance of the labor market.
Labor Day weekend marks the unofficial end of summer. That means back to school or back to work for many. For investors, it may mean a more active stock market, especially with two potential catalysts in the pipeline for September: new labor-market data and the Federal Reserve’s next policy meeting.
The stock market showed solid performance for the month of August. The Dow Jones Industrial Average DJIA gained 3.2% for the month, while the S&P 500 SPX rose 1.9% and Nasdaq Composite COMP advanced 1.6%. This pushed the stock market to all-time highs – with the S&P 500 achieving five record closes in August, and the Nasdaq achieving four. Meanwhile, the Dow closed at a record twice this past month, finally surpassing the previous highs it set in 2024.
The stock market has rallied substantially off of its April lows, with four consecutive months of gains. This may imply that the bulls have been in charge of the stock market lately, but those bulls could be banking on the Fed’s rate cuts to see if the rally can continue.
When economists and policymakers gathered at the Kansas City Federal Reserve’s annual economic symposium in Jackson Hole, Wyo., last month, Fed Chair Jerome Powell hinted that rate cuts may be on the table when central-bank officials meet on Sept. 16-17.
“With policy in restrictive territory, the baseline outlook and the shifting balance of risks may warrant adjusting our policy stance,” Powell said during his Jackson Hole speech.
Investors interpreted this as a sign that rate cuts are set to resume. The S&P 500 gained 1.5% on the day of Powell’s address, and on Friday investors were pricing in a 87% chance of a 25-basis-point cut in September, according to CME’s FedWatch tool.
“The Fed opened the door to rate cuts, but the size of that opening is going to depend on whether labor-market weakness continues to look like a bigger risk than rising inflation,” Ellen Zentner, chief economic strategist at Morgan Stanley Wealth Management, wrote in a note.
This reflects the balance the Fed aims to achieve with its dual mandate: ensuring both price stability and job growth.
Watching the labor market
David Stubbs, chief investment strategist at AlphaCore Wealth Advisory, told MarketWatch that this balance between jobs and inflation is what markets seem most focused on, but there’s uncertainty on both sides.
On one hand, the Fed has been keeping rates in restrictive territory to tamp down inflation, but uncertainty remains around the extent to which tariffs will result in higher prices. On the other hand, the labor market has been showing signs of slowing down, and there’s uncertainty around how much that will continue.
“I think that is why we’re going to see extreme sensitivity in the market around anything which shifts the narrative around growth and inflation,” Stubbs told MarketWatch.
With Friday’s personal-consumption expenditures data – the Fed’s preferred inflation gauge – mostly in line with expectations, this may put more attention on the jobs market, Zentner said.
Investors will get a slew of labor-market data next week. Data on job openings for the month of July is coming on Wednesday; ADP employment data and initial jobless claims will arrive on Thursday; and the government’s monthly employment report, with the unemployment rate and wage data, is set for Friday. This gives investors a lot to sink their teeth into.
“In his Jackson Hole speech, Chair Powell laid out a case for the Fed prioritizing the job market near term based on some of the weakness of recent jobs data,” Bill Adams, chief economist at Comerica Bank, told MarketWatch. “So the question going into the jobs report will be: Does the August report still show that same weakness?”
Adams said that a best-case scenario for financial markets would be if the upcoming jobs report showed modest growth of payrolls and a slight uptick in unemployment. This would indicate that the economy is not in a recession, but also show that there’s enough slack in the labor market to justify the Fed cutting rates.
A worst-case scenario, according to Adams, would be if the jobs report showed a drop in employment, a drop in the labor-force participation rate and a drop in the unemployment rate. This would point to a decline in labor supply at the same time that labor demand is weakening, which would be something the Fed may not have the tools to deal with.
Role of the Fed’s rate cuts going forward
The White House has been pressuring the Fed to lower rates. President Donald Trump has repeatedly called Powell “too late” in his monetary policy, threatened the Fed with a lawsuit over its headquarters renovation and is trying to fire Fed governor Lisa Cook. All this drama certainly hangs over the Fed ahead of its meeting.
Still, rate cuts aren’t guaranteed. But with cuts potentially on the table in September, investors will resume the dance of trying to determine when “bad news is good news,” and when bad news is simply bad news. That’s to say: When does softening economic data give the Fed room to cut rates further, which is bullish for stocks, and when does softening economic data point to a growth scare, which is bad for the market? It may come down to why the Fed is cutting rates, and what happens after the rate cuts.
Read: The 6 things to watch as Trump blitzes the Federal Reserve
Powell has implied that current interest rates are still in restrictive territory, which means rates are at a level seen as acting as a brake on economic activity. In this case, a rate cut could act as a boost to the market.
“The big picture is, where is neutral on the interest rates? No one really knows that, and the Fed acknowledges that they don’t know,” Stubbs told MarketWatch. “Neutral” is the level at which the fed-funds rate neither impedes nor accelerates growth; Stubbs said that he estimates neutral rates are around 3.5%, which would give the Fed some space to cut rates and stimulate growth.
But investors could get nervous if there are any signs that the Fed is cutting rates to stimulate an economy that needs saving.
“As an active investor, if we do get a cut, one of the first places I’m looking is: What are the banks actually doing with that?” Shelby McFaddin, a senior analyst at Motley Fool Asset Management, told MarketWatch.
McFaddin said she’d be looking at how much bank deposits change in response to those rate cuts, how mortgage rates reflect rate changes and whether banks change the way they’re assessing risk. She noted that how the financial sector digests rate cuts is something the stock-market rally hinges on.
“If there’s a structural issue, then that cash may not hit the system as fast as we would expect or may not go to the places we expect it to go,” McFaddin said.
This sets up how investors will be watching for rate cuts through the end of the year.
“I think post-Labor Day, markets will have to make a judgment about where the direction of travel is into the end of the year,” Stubbs told MarketWatch.
Stocks ended the final week of August modestly lower. The Dow Jones Industrial Average was down 0.2% for the week, while the S&P 500 shed 0.1% and Nasdaq Composite lost 0.2%. The U.S. employment report for the month of August will be released on Friday, Sept. 5.
-Gordon Gottsegen
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08-31-25 1200ET
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