Federal Reserve Chair Jerome Powell in his keynote JH speech shifted his signalling on near-term Fed policy, suggesting he’s open to lowering rates at next month’s meeting. “With policy in restrictive territory, the baseline outlook and the shifting balance of risks may warrant adjusting our policy stance,” he said. Barring a big surprise in either Aug NFP or the Aug CPI, we can now expect 25 bps cut in the 17th Sep FOMC meeting. This has been our call since the last 6 months and we continue to believe that we might see total 75 bps cut in REMCY25 & another 50-bps cut in Q1CY26. Powell also flagged the upcoming benchmark revision to nonfarm payrolls (NFP), which will likely lead to a large negative revision. This is scheduled for 9 September, when the FOMC are in their blackout period. There’s a notable difference between a labor market that’s in balance because both supply and demand are falling, and one that’s in balance amid both an increase in supply and demand (which we saw in previous years). With things as they are now, naturally, this implies higher downside risk. Our view is vindicated by the consistently high continuous jobless claims over the past few weeks which are near Sep’21 highs. Regarding future cuts, we believe US labor market will take a deep dive downwards from Sep NFP (to be released in Oct) which might be sub-zero. We believe the neutral run rate for monthly NFP is 75k and not 50k as certain Fed members made out the case. Hence zero or sub-zero monthly NFP nos will push Fed to take policy rates to neutral level of 3-3.25 rapidly by end of Q1CY26. On inflation, Powell noted that tariff price pressures are now “clearly visible” in inflation data, but reiterated that it is a “reasonable base case that [tariff] effects will be relatively short-lived.” He emphasized scenarios whereby inflation could prove more persistent, but was generally dismissive of each particular hawkish risk. He suggested that a weakening labor market made a wage price spiral unlikely and added that current measures of inflation expectations “appear to remain well anchored”. We believe tariff pass through could be much more gradual than we have been expecting. This could give the appearance of more persistent inflationary pressures even if stronger than usual goods prices are still a reflection of tariffs. Depending on details of upcoming inflation data, Fed officials could consider even consistently stronger inflation readings as unconcerning for persistent inflation risks (likely as long as longer-run inflation expectations remain anchored). We also think a more drawn-out pass-through scenario would be consistent with an even weaker growth backdrop that would imply downward pressure on prices more broadly. The clearest evidence that’s policy rates (and by extension longer-term and mortgage rates) are indeed still restrictive is continued weakness in the housing which is 33% of US economy. Even lumber prices, the best indicator for housing part of the US economy has broken through key supports. Lumber is one of the most sensitive barometers of future demand because it ties directly into housing, construction, and credit. When it rolls over this hard, it often means something deeper: builders pulling back, financing tightening, and consumers hesitating on big-ticket commitments. Going forward, we continue to remain received on 2yr USTs & 1yr-1yr US SOFR which we have been recommending since last 1 month. Markets are only pricing in 54 bps of cut for REMCY25 which to us could move to 75 bps if 1-2 months of weak NFP data happens. We are also bearish on DXY and expect 95 to be the first stop. (our report on 17th Aug had the same view).
