(Bloomberg) — Wall Street’s last holdouts for a US interest-rate cut in July are preparing for their clearest sign yet on whether they — or traders in the market — are correct about the likely path of Federal Reserve monetary policy.
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JPMorgan Chase & Co. and Citigroup Inc. are among the few banks still predicting that the Fed will ease next month. Traders all but ruled out a July cut back in April, and now expect steady rates until November, swap rates indicate. The case for earlier rate cuts has strengthened in recent days, however, helping drive the longest streak of global bond gains since December.
The monthly employment data to be released Friday — the last major data release before the Fed meets next week to set new rate projections for the rest of the year — may establish whether swaps traders or the holdouts are closer to the mark.
“The only thing that gets people moving back toward a July cut is substantially weaker labor market news,” said Greg Wilensky, head of US fixed income at Janus Henderson Investors. “If we get on-consensus numbers I think you’ll see people calling for July cuts roll that back.”
At the start of the year, forecasts for at least six quarter-point Fed rate cuts were common, and derivative contracts were priced accordingly. But progress toward lower inflation stalled and labor-market conditions stayed robust, removing the rationale for rate cuts.
Most other banks abandoned forecasts for Fed rate cuts before September weeks if not months ago. Over the past week, however, softness in data on job openings and private-sector job creation shifted the market-implied odds back in favor of Fed rate cuts beginning before December, and as early as September.
For the May employment report, economists surveyed by Bloomberg have a median forecast of 185,000 new nonfarm jobs, a slight increase from April’s 175,000, but among the lowest of the past year.
Citigroup’s forecast for a July rate cut — the first of four this year — “depends on softer labor market data including on Friday,” Andrew Hollenhorst, chief US economist at the bank, said on Wednesday. His team looks for nonfarm payrolls to increase by 140,000 and an unemployment rate of 4%, up from 3.9%.
The Fed’s rate-setting committee meets next week for the last time before July, and regardless of what happens with the May jobs data is unlikely to signal an intention for July, Hollenhorst said.
Fed Chair Jerome Powell “will explicitly keep all meetings on the table for a potential rate cut,” he said. “He might also emphasize that the committee is watching data and will make decisions on a meeting-by-meeting basis.”
The potential exists, however, for Fed policymakers to revise their quarterly forecasts for interest rates. In March, the median forecast was for three quarter-point rate cuts by year-end.
In late May, economists at Goldman Sachs Group Inc. and Nomura Securities moved their forecasts for the start of Fed rate cuts to September from July based in part of comments by Fed officials suggesting the threshold for easing has risen. For example, Fed Governor Christopher Waller said May 21 that “several more” months of good inflation data were needed.
JPMorgan economists retained their July rate-cut call based on April inflation readings that — though still higher than the Fed favors — at least moved in the right direction, Michael Feroli, chief US economist at JPMorgan, and colleagues said in a May 15 note.
“But we probably need to see some further cooling in labor-market activity for that to play out,” they said. JPMorgan estimates payrolls increased by 150,000 in May.
Expectations for what the Fed will do are critical to the performance of the bond market, where Treasury yields reached year-to-date highs in late April as expectations for rate cuts collapsed. Two-year yields, more sensitive than longer maturities to changes in the Fed’s rate, peaked above 5% and have retreated to around 4.7%.
“If these firms capitulate on a July cut, it just means that the total number of cuts we potentially get in 2024 continues to shrink,” said James Athey, a portfolio manager at Marlborough Investment Management Ltd. Athey expects labor market conditions to weaken and inflation to slow further, benefiting bonds as the year progresses.
There’s an inflection point where job creation falls short of growth in the labor force, and “when that kicks in, we know those dynamics feed off themselves,” he said.
–With assistance from Elizabeth Stanton.
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