The U.S. labor market delivered an unexpected result in July. This shook investor confidence. It also shifted assumptions about the Federal Reserve's next steps. With the new data, the likelihood of a rate hike at the Fed's September meeting has plummeted. According to Kalshi, the chance is now 35%. Earlier, the debate had seemed balanced at 50-50. The chances of a hike had climbed as high as nearly 58%. This was right after the Fed’s last decision at the end of July. The yield on two-year US Treasuries, which are sensitive to near-term moves in Fed monetary policy, fell eight basis points on Friday to 4.16% as traders cut bets on interest-rate hikes in the coming months. The 10-year rate was down six basis points at 4.62%.
The CME’s FedWatch tool paints a similar picture of shifting expectations. The probability of the Fed maintaining current interest rates in September has climbed to 60% as of now, up sharply from 45% just one day earlier on Thursday. A week prior, that possibility had been viewed as barely better than a coin toss. Traders are now pricing about a roughly 40% chance of such a move at the next scheduled decision in September, according to interest-rate swaps, compared to closer to 60% before the data.
The weaker jobs data caused a ripple effect. It drove Treasury yields down. It also sent stock markets upward. Investors seem to be factoring in a reduced risk of rate hikes. That is at least for now. If the labor market continues to cool, it could lead to a more cautious Fed approach. Additional rate increases may be considered cautiously. Some members had previously pushed for more hikes. This was due to higher energy prices from the U.S.-Iran conflict. Nonfarm payrolls decreased 23,000 last month following substantial downward revisions to the prior two months, Bureau of Labor Statistics data showed Friday. The unemployment rate fell to 4.1% as labor force participation continued to slide. “The headline number being negative is a total shock,” said Tom di Galoma, managing director at Mischler Financial Group. “I guess the Fed will not be tightening in September.”
In the July meeting, three officials on the Federal Open Market Committee voted in favor of a rate hike. However, they were in the minority as the Fed kept rates unchanged, citing strong and consistent job growth throughout 2026. Now, with a possible slowdown in hiring, the central bank may need to reconsider its pace of rate adjustments and the risks of further tightening the economy. Fed Chairman Kevin Warsh’s refusal to provide forward guidance further complicates the market’s response. Last week, the Fed held its key interest-rate tool unchanged, though three officials dissented in favor of a hike. In an interview with Punchbowl News posted on Friday, President Donald Trump reiterated his preference for lower interest rates while also acknowledging that Warsh is part of a board that votes on rate moves. Trump struck a softer tone than the sharp criticisms he threw at Warsh’s predecessor, Jerome Powell.
Attention is now turning to next week’s August 12 release of the Consumer Price Index. In June, the largest drop in prices in six years was recorded, largely due to falling energy costs. Yet, oil prices rose in July as Middle East tensions escalated, signaling potential volatility ahead. The surge in energy prices stemming from the US’s war with Iran has reignited worries regarding inflation, though a weaker-than-expected CPI print published last month helped ease some of those concerns. “If data looks somewhat softer in the next couple of months, especially when it comes to the inflation side, they are probably not going to want to hike,” Stephanie Roth, chief economist at Wolfe Research, said on Bloomberg TV. “They are going to want to see how the data progresses.”
Ellen Zentner is chief economic strategist at Morgan Stanley Wealth Management. She emphasized the importance of the coming inflation report. She noted, "Next week’s CPI numbers will likely be the key determinant." Even if hiring slows, unexpectedly high price increases could emerge. These could encourage more aggressive rate-hiking stances within the Fed. Jeffrey Rosenberg, senior portfolio manager at BlackRock, told Bloomberg Television that he “would be hesitant to write this report off as the revisions in the headline number are pointing to weakness. The market is not ignoring it, with a big hike probability coming out with the front-end rally.”
While September looks like a no-go, the CME still shows 55% odds for a hike in October. There is also a 75% chance in December. Although 2026 may still see tightening, the latest jobs data has changed the September meeting outlook. It is now a toss-up. Investors are bracing for a potentially more watchful stance from the central bank. To be sure, investors are still fully pricing a hike by year-end.