The economy is at a fork in the road

• The economy is at a decisive moment, and Friday's jobs report may provide answers.
• The last jobs report brought an unpleasant surprise when unemployment jumped up, causing the stock market to plunge.
• August's report — and the unemployment rate in particular — may indicate which direction the economy is headed.

Friday's jobs report is a big one.

That's because the US economy is at a critical point. The next batch of data could be a key indicator of whether the economy is sticking the soft landing or heading into a recession.

It'll also point toward how big the nation's central bank will go on interest rate cuts in its September 18 meeting. While it's looking almost certain that the rate cuts Americans have been hoping for will finally happen, the question is how deep those cuts will go.

So let's paint two scenarios, based on Friday's report, and both come down to one number.

If the unemployment rate spikes again — as it did in July's report — the stock market could plunge, mirroring what happened after that unwelcome surprise. Unemployment above July's 4.3% could indicate that the jobs market is in even more dire straights and the chances of a coming recession could go higher. Additionally, the Fed could decide to cut rates even deeper than the expected 25-basis-point cut.

On the other hand, if unemployment dips to 4.2% or below, it could be an indication that July's shockingly large increase was a blip and the job market isn't on a steep decline. The Fed could announce a 25-basis-point cut — the most likely scenario, according to market predictions — which will mean that while the economy is cooling, it doesn't need drastic intervention on its way to a soft landing.

The upcoming jobs report will clarify which of those two roads the Fed thinks we're on.

"It's really an opportunity for them to focus on the labor market and make sure that they are not inducing a more dramatic slowdown," Aaron Terrazas, chief economist at Glassdoor, told Business Insider.

A golden path or Recessionland

The Federal Reserve has held steady on interest rates for around a year — a decision called into question after July's disappointing jobs report.

The Fed will likely be using the upcoming data to determine whether July's weak employment numbers persist and are indicative of a recession or if that was just a bump in the road and the economy can carry on into the coveted soft landing.

"We've got to be thinking about where will we need to be to pull off what I call the golden path, which is to get inflation down from these epic heights to something like our target without having a serious recession," Chicago Fed President Austan Goolsbee told BI. "And so far, we did that in 2023. This looks like a little bit of that magic dust. It has carried over into 2024, but there's weakening on the labor market side and so we've got to be attentive."

Still, a 50-basis-point cut isn't guaranteed even if Friday's job gain and unemployment rate data are weak.

"I think the Fed will want to avoid being seen as excessively data-point dependent so that there would need to be a significant degree of weakness, very low payroll growth, or potentially a decline, and an increase in the unemployment rate for policymakers to suggest 50 basis points as the first rate cut," Gregory Daco, the chief economist of EY, told BI.

While the size of a rate cut is in question, Federal Reserve Chair Jerome Powell all but confirmed an interest-rate cut in September during his keynote speech at Jackson Hole last month and indicated that the Fed will be closely watching the incoming jobs data, saying that "the inflation and labor-market data show an evolving situation. The upside risks to inflation have diminished. And the downside risks to employment have increased."

July's unemployment rate of 4.3% was the highest since October 2021. A slight dip in this rate is expected for August, the forecast on Investing.com showed, and job growth is expected to tick up.

Terrazas said the question among economists right now is just how big of a cut the jobs report could prompt.

"If we do get a weak report, then I think 50 basis points is very clearly on the table," Terrazas said.

David Kelly, J.P. Morgan Asset Management's chief global strategist, thinks the Fed will cut rates in September and December — both times being 25 basis point cuts.

"A payroll gain of less than 100,000 or a rise in the unemployment rate to 4.4% or above would make a 50 basis point cut in September likely," Kelly told BI in a statement about the upcoming labor market report.

New data out Wednesday from the Bureau of Labor Statistics showed job openings fell for the second straight month in July, and the number of hires increased slightly.

"If we continue to get labor market data like today's report, then the pace of cutting is likely to be quick," Nick Bunker, economic research director for North America at the Indeed Hiring Lab, said on Wednesday. "Hopefully, the labor market can level off and a more deliberate pace of cuts can be undertaken. But the underlying trends in the data suggest that might not be the reality."

The Fed likely will also be considering the path of inflation as it decides how much to cut rates. Inflation has cooled and is now hovering just a little above the Fed's 2% target. New consumer price index data, an inflation measure, will be released before the FOMC meeting.

Inflation and the labor market have both cooled, but the much-sought soft landing could be in trouble. A recession isn't here either — even if some widely followed recession indicators have started to sound the alarm.

"I think the US economy is softening but not soft," Daco said.

Goolsbee also emphasized the importance of looking at the data over time rather than a single point, and he noted that even if the Fed does start cutting rates this year, "the mission of the central bank is never done."

"There is no declaring mission accomplished," he said. "It's a mistake to do that."

Will an interest rate cut impact your life or finances? Contact these reporters at mhoff@businessinsider.com, asheffey@businessinsider.com, and jkaplan@businessinsider.com.