Citi pushes back July Fed rate-cut bets, flags potential labor market loosening

Citi analysts now expect the Federal Reserve to begin cutting interest rates in September, revising their earlier call for a July cut, following the release of May's nonfarm payrolls report. While the U.S. added 139,000 jobs, exceeding estimates, downward revisions to previous months and contraction in services and manufacturing suggest a cooling economy. Citi projects 25-basis point cuts at each meeting through March of next year, totaling 125 basis points, aligning with market expectations for the Fed to remain on hold until September before easing monetary policy.

Analysis

Citi analysts have revised their forecast for the Federal Reserve's initial interest rate cut to September from July, attributing this shift to details from May’s nonfarm payrolls (NFP) report which suggest a potential loosening in the labor market. The U.S. economy added 139,000 jobs in May, exceeding economists' estimates of 126,000. However, this was counterbalanced by significant downward revisions to prior months: April's job gains were adjusted from 177,000 to 147,000, and March’s total was reduced by 65,000 to 120,000. While employment trended upwards in health care, hospitality, and social assistance, Federal employment declined by 22,000 in May, part of a 59,000 reduction since January, reportedly reflecting White House efforts to reduce the government workforce. Despite a stable unemployment rate at 4.2% and an acceleration in average hourly wage growth to 0.4% month-on-month from 0.2%, Citi analysts highlighted that separate gauges indicating contraction in services and manufacturing activity suggest a "cooling economy." Consequently, Citi projects the Fed will maintain current borrowing costs, stated at a range of 4.25% to 4.5%, through its June and July meetings, before initiating a 25-basis point rate cut in September. This is anticipated to be followed by similar cuts at each subsequent meeting through March of the next year, amounting to a total reduction of 125 basis points. This outlook aligns with broader market expectations, as the CME Group’s FedWatch Tool indicates a 54.5% probability of a 25-basis point cut in September. The Federal Reserve's recent pause in its rate-cutting cycle was partly attributed to uncertainty surrounding President Donald Trump’s aggressive tariff agenda.

Key Decisions for Investors

• Investors should recalibrate expectations for Federal Reserve easing, with September now emerging as the more probable timeframe for the commencement of rate reductions, potentially influencing strategies for fixed income and rate-sensitive equities.
• Closely monitor forthcoming leading economic indicators, particularly services and manufacturing activity data, as their potential continued contraction forms a key basis for the anticipated shift in monetary policy.
• Acknowledge the mixed signals within recent labor market data—balancing May's headline job growth against significant downward revisions for previous months and distinct sectoral trends such as declining federal employment—and prepare for potential market volatility as the Federal Reserve navigates these conflicting economic signals and political uncertainties, including tariff policies.