School's in session

With colleges and schools resuming, September always feels like a fresh start. The markets are studying economic data and Federal Reserve communication anew to determine when it will finally ease. In Jackson Hole, Wyo., Chair Jerome Powell all but promised he would announce the first cut at its policy-setting meeting on Sept. 18. So, the more pertinent question is the magnitude of that reduction in the fed funds rate and how fast the Fed reaches its terminal rate.

But the first test arrives Friday, with one of the most significant jobs reports in some time. The release of August's figures likely will have an oversized bearing on what the Fed will decide at its mid-September meeting. Average expectations via Bloomberg are for 165,000 added jobs, up from July's print of 114,000, and an unemployment rate of 4.2%, down from 4.3% the month prior.

With eight-and-a-half trading days between the employment report and the Federal Open Market Committee's (FOMC) meeting announcement markets will have ample time to discern and trade on the data. That's important because the markets reacted poorly to the meager July payroll number, swooning over concerns that a marked slowdown, or even a recession, could be around the corner.

That said, the response will not be even on both sides. A good-to-relatively strong jobs report likely prompts a 25-basis point cut in September. Conversely, a nonfarm payroll figure well below 100,000 or a substantially higher unemployment rate sets the table for a 50-basis point decrease. The difference is critical, of course, but particularly so as the markets have already priced in a full percentage point of cuts this year. With only three FOMC meetings remaining on the Fed's calendar, the math says that one must result in a half-point move. The strength or weakness of the August jobs report likely would shift in similar fashion to the Fed, repricing to 75 or even 50 basis points of cuts on a solid employment print or even more easing if the jobs numbers are decisively weak.

We can expect the bond market to behave as it has been in the event of a 25-basis point cut, as that would signal that the elusive soft landing remains a possibility. Against this backdrop, a resilient consumer should continue to spend and corporate bonds perform well, though with a bias toward higher quality. Speculative-grade companies might need a more aggressive easing cycle to ease their interest burden. A measured policy likely also would benefit mortgage-backed securities.

In contrast, fixed-income investors would probably greet a 50 basis-point cut with fervor initially, but then volatility could rise if they think a recession might still be in the offing. Markets will look toward the next round of material data releases on jobs and consumer health for direction on the economy and hints as to the FOMC's next move as we wait through all of October and past the elections until their next meeting on Nov. 7. Higher-quality securities and fixed-income sectors typically work well in such an environment, as lower-credit-quality sectors with greater risk tend to struggle in a risk-off environment.

The key element is that in most monetary policy cycles, the Fed has needed to lower rates quickly rather than gradually. That accelerated pace signals it reacting to a significant problem in the economy, and companies and consumers retrench as a recession emerges. This time, policymakers have said they are trying to establish a gradual easing, with quarter-point cuts every, or perhaps every other, meeting. They've made clear that each decision will be heavily dependent on the data. To the extent that this plan prevails, it should promote stability, as markets react better to known policy. But just because the Fed has outlined its plan like a teacher's syllabus doesn't mean there won't be surprises or volatility. Expect pop quizzes along the way.