How the Government Shutdown Could Impact Rate Cuts

Brent Schutte, CFA, is chief investment officer of the Northwestern Mutual Wealth Management Company.

As the federal government shutdown entered its third day on Friday and the labor markets showed continued signs of cooling, Wall Street remained remarkably unfazed.

While the budget battle led to frozen funds in Washington, an artificial intelligence-fueled deal-making spree unleashed billions in fresh capital across Silicon Valley. From Global Infrastructure Partners’ reported $40 billion plans¹ to acquire Aligned Data Centers to Japan’s Hitachi’s new partnership with OpenAI—one day after a share sale boosted its valuation to $500 billion—the West Coast windfall has fueled no shortage of investor confidence.

But is the optimism warranted? Last week’s AI frenzy, juxtaposed by the chaos on Capitol Hill, makes for a powerful example of how bifurcated the economy and markets have become. While more interest rate-sensitive segments of the economy have felt the impact of rising inflation and a softening labor market, the “Magnificent Seven” stocks and their peers have continued to drive a large portion of the market's returns amid bullish bets on tech.

While the economy may appear resilient on the surface, cracks appear to be forming in the labor market. Employment has historically served as the canary in the coalmine when it comes to the threat of future economic weakness. Those cries have grown more resounding in recent months amid slowing job growth, lower labor force participation and weakening demand.

U.S. employers announced 54,064 job cuts in September, down 37 percent from the 85,979 cuts announced in August and 26 percent from the 72,821 announced in September 2024, according to the latest Challenger job cuts report. September marked the third time this year that job cuts were lower year-over-year, reflecting limited layoffs in a trend consistent with today’s “low hire, low fire” environment in which the demand for and supply of workers are declining simultaneously.

Adding to the “low hire” part of the equation, employers plan to add 204,939 jobs, according to the report, down 58 percent from the 483,590 announced hiring plans through September 2024. Much of that stems from a drop in seasonal hiring announcements. Challenger tracked 100,800 seasonal hiring plans last month, down from 401,850 announced by the beginning of October 2024. “September marks the lowest year-to-date hiring plans since 2009, when 169,385 new hires were recorded,” the report notes.

Evidence of a weakening jobs market played a key role in the Federal Reserve’s decision to lower its benchmark interest rate by 0.25 percentage point last month, its first cut since December. “In this less dynamic and somewhat softer labor market, the downside risks to employment have risen,” the U.S. central bank’s Chair Jerome Powell noted during a speech in Rhode Island last month.

The Fed has penciled in two additional rate cuts for 2025, with one to potentially follow later this month, but has held off from making any hasty moves given the economy’s delicate state and uncertainty surrounding the long-term impacts of tariffs. “Near-term risks to inflation are tilted to the upside and risks to employment to the downside. … If we ease too aggressively, we could leave the inflation job unfinished and need to reverse course later to fully restore 2 percent inflation. If we maintain restrictive policy too long, the labor market could soften unnecessarily,” Powell explained.

The decision of how quickly to lower interest rates will only become more complicated, however, if the government shutdown continues to deprive monetary policymakers of key data points that help it evaluate the state of the economy. The Bureau of Labor Statistics (BLS) did not publish its highly anticipated jobs report on Friday, while other much-watched data sources, including this week’s Consumer Price Index report, could also be withheld if a deal is not reached soon.

The good news, however, is that here at the Northwestern Mutual Wealth Management Company, we don’t rely heavily upon any one particular data point to inform our investment decisions. Rather, we build a mosaic around a vast array of data, using it to inform a well-balanced, long-term investment strategy that places diversification above all else.

Let’s dive further into this week’s data.

Wall Street Wrap

Since federal jobs data was not released on Friday amid the federal government shutdown, the Institute for Supply Management’s (ISM) September manufacturing and services Purchasing Managers Index (PMI) reports garnered special focus.

The indexes registered a combined “economy-weighted” reading of 49.9 last month (readings below 50 signal contraction), painting the picture of an increasingly bifurcated and delicate economy defined by a slowing labor market and still elevated inflation.

Manufacturing comes under pressure amid rising prices, weaning demand: Manufacturing activity contracted for the seventh consecutive month, registering a reading of 49.1. This marks a 0.4-percentage-point increase compared to August’s 48.7; however, this is the 33rd time in the past 35 readings this index has been in contraction.

Readings for new orders came in at 48.9 percent, 2.5 points lower than August’s 51.4 percent. This marks a reversal from last month’s brief expansion, which had previously interrupted six consecutive months of contraction. The production index added 3.2 points to 51 percent, signaling an expansion from last month’s 47.8.

“Last month’s increase in new orders (an index gain of 4.3 percentage points from July to August) seems to have flowed through to production but does not appear to be sustainable given the subsequent drop in new orders in September,” wrote Susan Spence, chair of the ISM’s Manufacturing Business Survey Committee.

“Looking at the manufacturing economy, 67 percent of the sector’s gross domestic product (GDP) contracted in September, down from 69 percent in August. Twenty-eight percent of GDP is strongly contracting (registering a composite PMI of 45 percent or lower), up from 4 percent in August,” she added, noting that the share of sector GDP with a PMI reading of 45 or below is typically an indicator of overall manufacturing weakness.

Manufacturing backlogs remained in contraction territory for the 36th consecutive month after a 27-month period of expansion, suggesting wavering demand even as manufacturing inventories remain at the lowest levels seen in the past three years.

This uncertain demand has placed further stress on the labor market: Manufacturing employment remains in contraction territory, registering a reading of below 50 for 30 of the past 33 months. None of the top six manufacturing sectors reported higher levels of employment last month, Spence noted, while three reported reducing headcounts.

Finally, manufacturing prices fell by 1.8 percentage points in September to 61.9, suggesting that raw materials prices have increased for the 12th consecutive month, albeit at a slower rate compared to August.

Services sector grows increasingly fragile: Services neither expanded nor contracted in September, reaching a breakeven point reading of 50, down from an August reading of 52. However, ISM’s Business Activity Index moved into contraction territory last month for the first time since May 2020, falling 5.1 percentage points to 49.9 percent. Outside of the COVID-19 pandemic, the index hasn’t been in contraction since July 2009, in the aftermath of the Great Financial Crisis.

“The past relationship between the services PMI and the overall economy indicates that the services PMI for September (50 percent) corresponds to a 0.4-percentage-point increase in real GDP on an annualized basis,” Steve Miller, chair of ISM’s Services Business Survey Committee, noted, underscoring the delicate balance between services activity and economic growth.

Similar to manufacturing, services employment data painted the picture of a softening labor market: ISM’s services employment index added 0.7 percentage point, rising to 47.2 percent but remaining in contraction territory for the fourth consecutive month.

Services prices also raised red flags: ISM’s services prices index registered 69.4 percent in September, a 0.2-percentage-point increase from 69.2 percent. The index has exceeded 60 percent for 10 straight months, the longest streak of its kind since the 30 consecutive readings above 60 percent between October 2020 and March 2023 and another sign of sticky inflation.

Falling labor differential suggests rising unemployment: The Conference Board's Consumer Confidence Index fell 3.6 points in September to 94.2, down from 97.8 in August in a sign that consumers are taking note of slower labor conditions. The Present Situation Index, which measures consumers’ assessment of current business and labor market conditions, fell by seven points to 125.4. The Expectations Index, which measures Americans’ short-term expectations for their income, business conditions and the job market, fell by 1.3 points to 73.4. The survey showed that the number of consumers who viewed jobs as “hard to get” remained unchanged from August at around 19 percent—hovering near the highest level seen since February 2021. Respondents who said jobs were “plentiful” fell to 26.9 percent, down from 30.2 percent in August and the lowest number seen since February 2021.

These falling expectations caused the Conference Board’s much-watched labor differential to fall for the ninth consecutive month, to 7.8 in September from 11.1 in August. We often note that the labor differential has an inverse correlation to the national unemployment rate, meaning this latest decline could foreshadow a rise in unemployment in the coming months.

Compare that with the percentage of respondents who reported expecting stock prices to increase over the next 12 months, which has remained unchanged at 48.9 percent since July, and the curious mismatch between market bullishness and labor market concerns widens further.

Private-sector hiring stalls: A hiring slowdown was also apparent in the private sector, according to ADP’s latest National Employment Report. Private employers shed 32,000 jobs in September in a significant drop from August’s downward-revised loss of 3,000 jobs. “Despite the strong economic growth we saw in the second quarter, this month's release further validates what we’ve been seeing in the labor market: that U.S. employers have been cautious with hiring,” said Dr. Nela Richardson, chief economist, ADP.

The week ahead

Tuesday: The Federal Reserve’s report on consumer credit for August is scheduled to be released at 3:00 p.m. EDT. In July, this report showed that rising credit card debt coincided with stronger household spending. We’ll be monitoring this for signs of further consumer spending strength or weakness.

Wednesday: Minutes from the Federal Open Market Committee’s September meeting will be released, lending insight into the U.S. central bank’s decision to reduce the federal funds rate by 25 basis points to a range of 4–4.25 percent. The minutes will also provide a view into policymakers’ economic outlook, financial conditions and their reasons for policy decisions, offering more context than the initial policy statement.

Friday: The University of Michigan’s preliminary Consumer Sentiment report on Friday offers one of the first key pieces of economic data for October, providing key insights into long-term inflation expectations. Last month, five- to 10-year inflation expectations checked in at 3.7 percent, the highest reading since 1993 aside from the period March – June of this year. We should note that the percentage of respondents last month who reported expecting more unemployment reached 65—a reading this high has occurred only during periods of rising unemployment and economic contractions. We will be watching to see if this upward trend continues.

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