Bad employment report

As we get into macroeconomics we will be discussing employment and unemployment. Today saw the release of the Aug Non Farm payroll report ( basically non farm sector job growth). The report was unexpectedly bad and you can read about it here.

The Federal Reserve is widely expected to lower the fed funds rate -- the rate at which banks lend to each other -- for the first time in over four years when it meets on Sept. 18, by 25 basis points to 5%. It has already lowered the discount rate it charges banks that borrow directly from the Fed by 50 basis points.

The key question I want you to ask yourself is why a weak employment report would cause the Federal reserve to "cut" the fed funds rate (currently at 5.25%, expected to be cut to 5.0 or 4.75% on Sep 18th).

Answer (you may not understand this until we cover the relevant section).

The federal reserve has a dual mandate, full employment and price stability. Up until recently the Fed was primarily worried about inflation or price stability. Therefore they had what is called a hawkish bias. That is, they were more inclined to raise rather than lower rates. Higher rates increase borrowing costs and slow the economy and the price level down.

Now with the housing market in a full blown recession, there is worry that this particular market will cause a full blown economy wide recession. The latest employment report signalled that this probability has increased since firms have stopped hiring workers, at least for this month. Therefore, the markets are now expecting the Fed to cut the rate in order to lower borrowing costs and provide an incentive for firms to hire workers and boost the growth rate.