The U.S. jobs report, due later this week, will test whether the economy remains resilient enough for the Federal Reserve to maintain its current monetary policy. A weak labor market could reignite the reasons for interest rate cuts that were almost buried by the Iran war.

Robust economic growth and concerns about war-induced inflation have led markets to expect no interest rate adjustments this year. This contrasts sharply with January, when federal funds rate futures traders anticipated two 25-basis-point rate cuts in 2026.

Analysts point out that the key factor in whether the Federal Reserve cuts interest rates is the performance of the labor market. While oil prices may return to normal levels, inflation concerns are likely to persist. With job growth remaining strong, the market expects interest rates to remain at higher levels for an extended period.

Resilient economic data raises the bar for interest rate cuts significantly.

1. Reasons for interest rate cuts due to weakened economic resilience

Nomura's U.S. interest rate analyst stated, "The economic situation and data have been quite resilient during the conflict. Even without the uncertainty from Iran, there are reasons to believe that the current economy does not require substantial easing policies."

Analysts say that any signs of a significant deterioration in the labor market could prompt Federal Reserve officials to consider cutting interest rates. However, given last month's strong jobs report, solid other economic data, and persistently high inflation, even a very weak jobs report this time is unlikely to change the Fed's consensus. Investors have been hoping for rate cuts to support the rise in stock and other asset prices this year.

Even if the war is resolved in the short term, strong data has weakened the case for interest rate cuts. The U.S. added 178,000 jobs in March, nearly three times the 60,000 expected by economists, and the unemployment rate also fell slightly to 4.3%.

2. Market repricing: Interest rates "remain high for an extended period"

The 10-year U.S. Treasury yield has risen from 3.94% before the outbreak of war on February 28 to around 4.4%, while the yield on the interest rate-sensitive two-year Treasury note has also risen from 3.38% to around 3.9%. This broad repricing reflects that the market is accepting the reality that interest rates will "remain at higher levels for an extended period."

3. Increased internal divisions within the Federal Reserve

There are currently few signs that easing policies are a top priority for central bank officials. The Federal Reserve kept interest rates unchanged at its most recent meeting, but three policymakers objected to wording that suggested a preference for rate cuts.

"Between the two meetings, voices supporting a more neutral stance on the future path of interest rates are growing," said a U.S. interest rate strategist at BMO Capital Markets.

Federal Reserve Chairman Jerome Powell stated at a press conference following last week's meeting that the Fed might abandon its dovish stance as early as its June 16-17 meeting. Analysts indicate that the conditions supporting a reduction in the federal funds rate target from the current 3.50%-3.75% range have tightened significantly.

The U.S. economy regained momentum in the first quarter, driven by increased corporate investment in artificial intelligence and a rebound in government spending. Consumer spending remained resilient despite higher gasoline prices.

“If the Fed cuts rates, it won’t be because of good news on inflation data,” the strategist said, “but because of bad news from the labor market.” He added that a weak labor market needs to be reflected in multiple reports, and most likely it will manifest as a continued rise in the unemployment rate.

The U.S. Labor Department will release the April non-farm payrolls report on Friday. Economists expect 62,000 new jobs to be added last month, with the unemployment rate remaining unchanged at 4.3%.

4. Inflationary pressures remain an obstacle to interest rate cuts.

Analysts warn that even if oil prices return to normal after a ceasefire, inflation was already on a worrying trajectory before the conflict even began. This means that while resolving the Middle East conflict would remove one obstacle, it wouldn't fully pave the way for interest rate cuts.

Nomura's head of U.S. interest rate strategy points out several factors that are hindering the market's continued expectations of a Fed tightening policy, including: the Senate confirmation that former Fed Governor Warsh will succeed Powell as Fed chairman; stable long-term inflation expectations; and what he calls the Fed's policy committee's "implicit dovish bias." However, he warns that unless economic data deteriorates, this bias alone is insufficient to reignite market expectations for a significant rate cut.

The head of U.S. interest rates and mortgage trading at Manulife Investment Management said one factor that could mask underlying economic weakness is an unusually large wave of tax refunds, which has helped consumers absorb higher energy costs. He stated that the speed at which this buffer wears off, and whether the impact of high oil prices will manifest in consumption or other economic data, will be key variables for the market in assessing the Federal Reserve's policy path.

With the Federal Reserve's window for interest rate cuts narrowing, employment data has become the focus of attention.

In conclusion, the threshold for the Federal Reserve to cut interest rates has clearly increased. Strong economic growth, a robust job market, and persistent inflationary pressures collectively provide strong support for maintaining current interest rate levels. The market has accepted the expectation that interest rates will remain at a high level for an extended period.

Against this backdrop, the performance of the labor market has become a key variable in whether or not interest rates will be cut. Only if Friday's non-farm payroll report and subsequent data continue to show signs of weakness, particularly a trend of rising unemployment, might the window for interest rate cuts reopen. Otherwise, a weak report alone, or a short-term easing of tensions in the Middle East, is unlikely to shake the Federal Reserve's current cautious stance.

Investors need to closely monitor employment data, changes in inflation expectations, and the evolution of the Federal Reserve's internal policy stance in order to judge the possible shift in the policy path in the second half of the year.