Opinions

We have been consistent in our view that US employment is worsening due to AI led productivity growth in US corporates & tariff uncertainties in small & medium business. Our own view on employment is that Oct NFP is it were to be released on 5th Nov as scheduled might have shown UR (Unemployment Ratio) at 4.5% with headline NFP at -25k. But as long as there is no data, we have to agree to Powell’s logic of driving slow in foggy conditions. As long as data is not there, FOMC won’t see the weakness in employment and hence not be motivated for a cut when inflation is still elevated. Hence we now see a December pause as the most likely outcome in absence of US employment data. We continue to expect 3 more consecutive cuts of 25 bps each when ever the employment data resumes. Hence in short term, we are bullish on DXY expecting to test 100.50 & 10yr UST testing 4.20. It was interesting to see the group dynamics at play in Oct FOMC. It appears to us that Powell has no more control on any fraction in the FOMC, whether pro cuts or status quo. The discussion around neutral rates also implies that without employment data at hand, the status quo group wont be agreeing to any further cuts. Powell himself sounded dovish on inflation when he said that tariff-driven inflation would be short-lived, and suggested that tariffs were contributing 50-60bp to current y-o-y inflation. Powell went further to say “inflation away from tariffs is actually not so far from our 2% goal,” echoing dovish remarks from officials like Governors Waller and Bowman. So it is not inflation but employment data which would be needed to bring in more cuts. Moving on to QT, the Committee announced that it will conclude balance sheet runoff on December 1, broadly in line with our expectations. Thereafter the Fed will roll over maturing Treasury securities via non-competitive bids at Treasury auctions, proportional to announced offering amounts, and reinvest MBS principal payments into Treasury bills. The end of quantitative tightening via runoff of the Federal Reserve's assets beginning in December will start the clock ticking toward a resumption of asset purchases in 2026 as Fed liabilities naturally increase. Demand for bank reserves and currency in circulation could force the central bank to begin buying Treasuries as soon as from Jan’26. More Fed bill purchases pave the way for upcoming shift in Treasury funding strategy. Although the Fed’s decision this week to reinvest MBS proceeds exclusively into bills from December onward was modest, it nonetheless aligns with the notion of transitioning towards a shorter maturity SOMA portfolio. We estimate the Fed will purchase $360bn of bills in 2026, with roughly 2/3 of that due to MBS reinvestments and 1/3 due to reserve management purchases.

We expect BOJ policy rate to remain unchanged in the 30th Oct meeting. It will be interesting to see whether other Policy Board members besides Naoki Tamura and Hajime Takata support a rate hike. In the outlook report, we expect upward revisions to both FY25 GDP growth and inflation forecasts, but any such revisions will reflect better-than-expected earnings and yen depreciation, and probably not point to any changes in the BOJ's outlook for the economy or inflation. Expectations for a rate hike in October have receded, in part due to the Takaichi trade. We look for coordination between the new government and the BOJ resulting into a Dec hike by BOJ. We believe that economic indicators released since the previous MPM in September generally justified an October rate hike. In particular, the Tankan survey for September showed an improvement in the business conditions diffusion index (DI) for large manufacturing companies which are relatively strongly affected by tariffs. But the surprise win of Takaichi in local LDP elections meant that Oct hike is now improbable. Takaichi’s broad framework for combating inflation, based on a high-pressure economy approach of proactive but responsible fiscal policy and maintaining accommodative monetary policy, gave rise to stage one of the so-called Takaichi trade: strong equities & a weak yen. Even if the BoJ had considered an October rate hike, it would have been difficult to achieve sufficient communication with the new Takaichi administration by the October meeting. Going forward, while it is a close call between Dec and Jan for the next 25 bps hike by BOJ, we prefer Dec as there are hardly 20 business days between Dec and Jan meetings. In addition, US treasury secretary Bessent & President Trump have time and again pointed out the delayed rate hikes of BOJ artificially depreciating JPY. Also, by 19th Dec, BOJ will have seen if Fed does cut by 25bps in it’s 11th Dec meeting. All these factors lead us to believe that a 25bps rate hike justified for economic reasons and delayed for political reasons shall come eventually in the 19th Dec BOJ meet.

The FOMC will likely deliver a second consecutive 25bp cut at next week’s October meeting along with a dovish dissent from Governor Miran. Powell’s press conference will likely reiterate some easing bias in light of yesterday’s soft CPI prints but Powell might still use the meeting-by-meeting framework for future policy decisions. More importantly we expect an announcement ending QT at this meeting. Recent signs of pressure in funding markets suggest reserves are no longer “abundant,” accelerating the timeline for ending QT and an eventual pivot to reserve management purchases. We expect MBS rundown to continue, with proceeds reinvested into treasury bills. We continue to believe in a front-loaded rate cut cycle by Fed of 25 bps each in the next 4 meetings bringing the terminal rate to 3% by March’26. Inflation is remaining well behaved in spite of tariff pressures on goods prices due to weakening shelter prices. Private employment data is showing cracks all over the place and is likely to show a large -ve no in Oct NFP if it were to be released in early Nov. A lack of meaningful political movement keeps us thinking that the government shutdown will continue into November. In our base case, the government will reopen in mid-November, but the risk is an even more extended shutdown. A mid-November reopening would mean the September, October, and November jobs reports might all be released in late November and early December, adding to volatility in markets. We believe as we move into end CY25, we are likely to see subdued employment nos as companies find themselves facing low consumption trends due to higher prices or consumption sacrifices due to higher prices. For cost rationalisation purposes, companies might tip the balance towards more firings than current state of low firing low hiring. By that time, tariff impact in good prices might have already played out leading to Fed prioritising it’s employment mandate over the price stability mandate.

Our core view on US macros this year has been that upside risks to inflation were being overstated while downside risks to employment were underestimated. Fed officials remain more concerned about persistent above-target inflation than we are, but recent data have convinced Powell and the committee to resume returning rates to neutral. We expect the perceived balance of risks to continue to shift dovish, keeping officials cutting policy rates 25bp at each of the next four meetings. The risk is that policymakers decide either neutral is lower or that rates need to be accommodative, leading policy rates to decline below 3%. Despite the dovish revision to the expected rate path, economic projections were surprisingly hawkish. This suggests a low threshold for delivering additional insurance cuts in the near term and less vigilance on inflation risks. Less emphasis on inflation risks and a likely shift in Fed leadership next year leads us to forecast terminal rate below 3% by mid CY26. We believe the majority of Fed are yet to admit that their inflation expectations for most of CY25 was higher than actuals. For the same reason, the core PCE of CY26 was again revised higher where as it should be lower in our view if we agree that tariff shock is a one-time price effect. In addition, base effects will bring CY26’s core PCE lower than CY’25 core PCE. Hence, we continue to believe front loaded 25bps rate cuts for each of the next 4 meetings. In BOJ, more of the same status quo continued except for a new announcement of a 100year plan of selling ETFs & J-REITs. While the start date for the sales is yet to be determined, the BoJ plans to sell approximately JPY 330 billion (at book value) of ETFs and JPY 5 billion (at book value) of J-REITs annually. However, the pace of sales may be reviewed in the future. As of September 10, the BoJ's holdings of ETFs and J-REITs at book value stood at JPY 37.1862 trillion and JPY 655 billion, respectively. This implies that it would take 113 years to complete the sale of ETFs and 131 years for J-REITs. Also, Tamura and Takata each submitted a proposal for a rate hike to 0.75%. Since the new BoJ Law came into effect in 1998, there have been three instances when some of the policy board members have proposed a rate hike, which was subsequently voted down: July 2000, January 2007, and December 2024. In all these cases, a rate hike was decided at the subsequent meeting. We continue to believe BOJ is far behind the curve and should ideally by 50 bps higher at current levels of output and inflation. While the LDP presidential election on October 4 could also be a hurdle, we now believe it is no longer as high a hurdle, given that the BoJ has demonstrated courage to decide on ETF sales before the presidential election. We believe BOJ will hike by 25 bps in it’s Oct meeting as well as 50 bps in CY26.

The Bank of Japan will likely stand pat next week. We do not expect Governor Ueda to provide any new insight about specific timing of a next rate hike, although the BoJ will continue to argue for a resumption of policy normalization. We assume that the BoJ’s primary objective at the September meeting is to maximize its optionality in terms of the timing of policy moves, given the massive uncertainty concerning Japanese politics and the Fed easing. Local politics overshadow efficient monetary decision making currently in Japan. LDP is likely to elect a new leader via a full ballot of the party membership to be held on October 4. We believe amongst two chief contenders, Koizumi is more likely to win than Takaichi. Senior leaders including Aso, Kishida, and Suga want to stop Takaichi from becoming the new party president. Ishiba’s departure was engineered by an unofficial alliance of Aso, Kishida and Suga. Their common interest is to prevent Takaichi from becoming Ishiba’s successor. Whoever becomes prime minister, the coalition’s minority position means a fiscal expansion is all but certain. The key question is whether the coming fiscal expansion will be accompanied by political pressure on the BoJ to slow—or abandon—its program of monetary tightening. There are good reasons to believe the incoming premier will find it expedient to maintain the show of BoJ independence. First and foremost being Japan relationship with US. US Treasury secretary Scott Bessent recently rebuking the BoJ for failing to raise interest rates more rapidly, even though Japanese inflation is running hot by recent historical standards. Having agreed relatively favourable tariff rates with the US, Japanese policymakers will not want to risk fresh tariff increases in retaliation for their perceived deliberate undervaluation of the yen via an excessively loose monetary policy. 2nd being rising food prices especially rice prices won't allow any future PM to lean against BOJ hikes. Hence the recent dynamics in Japanese financial markets—a steepening yield curve, rising equity prices and a gradually strengthening yen—are likely to remain in place, no matter who arrives in office as Japan’s next prime minister. The key focus of next week's meeting will be the presence or absence of a rate hike proposal. Since the enactment of the new Bank of Japan Law in 1998, there have been three instances (July 2000, January 2007, and December 2024) where a rate hike proposed by some Policy Board members was rejected, but in all those cases, a rate hike was decided at the subsequent MPM. If a rate hike is proposed, it will likely heighten the momentum for a rate hike within the BoJ towards October which is our view too. If it were not for domestic political uncertainties, an October hike was a done deal instead of current market pricing of only 30% probability. Massive and consecutive downward revisions in the US labor data and consequent changes in future pricing of Fed easing have also not changed the Dollar/Yen FX rate that much. Thus, the odds of Japanese auto sector being squeezed both by 15% tariff and a skyrocketing Yen appear to be quite low, at least for now. Hence the possibility of an Oct hike wont impact Japan’s exports significantly via the fx channel. The BoJ provides a uselessly wide range of estimates of neutral rate somewhere between -1% to 0.5% on a real basis. A mechanical translation implies the nominal neutral rates are somewhere between 1% and 2.5%, assuming 2% annual inflation. Hence, we believe that an October hike is very much probable. We continue to believe in JPY testing 140 odd levels by Dec’25.

We expect the Fed to deliver a 25bp rate cut at next week’s FOMC meeting and signal that more reductions are likely to follow over the remaining meetings this year. The median dot of the updated SEP will likely show 75bps of total reductions for 2025, 25bps more than in June. We expect four dissents against the decision to ease 25bp. Governors Waller, Bowman, and Miran (if confirmed in time) will likely vote in favor of a larger 50bp rate cut, while we expect a hawkish dissent from a regional bank president – most likely Kansas City Fed president Schmid. Stephen Miran could well be voting next week, and Lisa Cook might not be. Either way, it will not affect the FOMC going for a 25 bp cut. After cutting policy rates 25bp, Chair Powell is likely to guide toward a series of further rate cuts, noting that downside risk to employment has increased further following recently softer jobs data. We expect median “dots” to signal 75bp of rate cuts this year and for Chair Powell to indicate that rate cuts at upcoming meetings are likely given the shifting balance of risks. We have been highlighting for the past few months that the employment mandate of Fed will take priority over it’s price stability mandate sooner than later. We believe employment might come under more stress as we see job losses picking up and labor demand go down further. We expect Oct NFP (to be released in Nov) to be -ve with UR at 4.5%. Is there a case for a 50bps cut: Yes, there is a 20% probability that FOMC goes for a 50-bps cut but doing that will be an admission of being late by Fed Chair Powell of which Trump frequently accuses him. In addition, it might spook the stable US equity markets about what the Fed can see and it does not. Also, it might raise questions about the independence of Fed and might look like a decision under pressure from President Trump. Hence, we rule it out. Our base case is 75 bps of cuts in REMCY25 and another 50-bps cut in Q1CY26. This has been our view since past few months and we maintain the same. We see current bump up in super core service inflation as transitory (falling employment-lower wages-lower service demand) & goods inflation to peak out by Oct CPI. By Nov the employment inflation mix might have turned decisively in favor of Fed rate reaching to terminal 3% rate by Q1CY26.