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FED: Strong Jobs Could Build Support For Two-Phase Rate Cut Approach (2/2)

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Recent data including the GDP/GDI revisions cited by Powell are signaling to the Fed that downside risks are less prevalent - but more needs to be seen to convince them that upside risks are coming into view. Indeed the fact that inflation has been coming down more swiftly in recent months than previously anticipated seems suggestive to Fed leadership that a soft landing remains within reach.

  • Next week's September CPI print suddenly becomes more interesting, whereas it had almost been an afterthought given the increased emphasis on the labor market. It will take a very strong upside CPI surprise (that translates into PCE terms), not just a failure to decelerate as expected (by 0.1pp vs August for both headline and core, per BBG consensus) to force the FOMC to consider holding.
  • If it's soft, though, the FOMC will probably see that as providing continued room to remove what they perceive as policy restrictiveness in the near-term before reassessing in early 2025. Indeed the likes of Gov Waller have since the September meeting appeared to be concerned that inflation was undershooting, and concern over a reacceleration in growth and inflation appears to be very limited.
  • As Waller, who said his base case was 25bp cuts in Nov and Dec put it on Sep 20, “If labor market data worsens, or if the inflation data continues to come in softer than everybody was expecting, then you can see going at a faster pace." Note the "or".
  • If the labor data - including but beyond nonfarm payrolls - start looking like there is a real re-tightening of the labor market underway in Q4, and inflation doesn't peter out as expected (core PCE seen at 2.6% Y/Y in Q4), there will be real conversations about slowing the pace of policy easing.
  • But that is probably a conversation for early 2024 and is unlikely to make much difference to the intention to cut in Nov and Dec. Overall, the data since the September meeting tilt the balance toward the "recalibration" approach espoused by Richmond's Barkin, where there is an initial phase of cuts and a reassessment before any commitment to moving to perceived neutral; versus the dovish aggressiveness of Chicago's Goolsbee who sees policy as far too restrictive, warranting significant cuts over the next 12 months.
  • Both approaches could get rates from the 4.4% end-2024 Dot Plot median to the 3.4% end-2024 median, rather than derail the easing process altogether - but the more patient approach probably implies a quarterly cadence of 25bp cuts, rather than front-loading at the first half of the year. Implied rates appear to be moving in that direction following the September employment report.
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Recent data including the GDP/GDI revisions cited by Powell are signaling to the Fed that downside risks are less prevalent - but more needs to be seen to convince them that upside risks are coming into view. Indeed the fact that inflation has been coming down more swiftly in recent months than previously anticipated seems suggestive to Fed leadership that a soft landing remains within reach.

  • Next week's September CPI print suddenly becomes more interesting, whereas it had almost been an afterthought given the increased emphasis on the labor market. It will take a very strong upside CPI surprise (that translates into PCE terms), not just a failure to decelerate as expected (by 0.1pp vs August for both headline and core, per BBG consensus) to force the FOMC to consider holding.
  • If it's soft, though, the FOMC will probably see that as providing continued room to remove what they perceive as policy restrictiveness in the near-term before reassessing in early 2025. Indeed the likes of Gov Waller have since the September meeting appeared to be concerned that inflation was undershooting, and concern over a reacceleration in growth and inflation appears to be very limited.
  • As Waller, who said his base case was 25bp cuts in Nov and Dec put it on Sep 20, “If labor market data worsens, or if the inflation data continues to come in softer than everybody was expecting, then you can see going at a faster pace." Note the "or".
  • If the labor data - including but beyond nonfarm payrolls - start looking like there is a real re-tightening of the labor market underway in Q4, and inflation doesn't peter out as expected (core PCE seen at 2.6% Y/Y in Q4), there will be real conversations about slowing the pace of policy easing.
  • But that is probably a conversation for early 2024 and is unlikely to make much difference to the intention to cut in Nov and Dec. Overall, the data since the September meeting tilt the balance toward the "recalibration" approach espoused by Richmond's Barkin, where there is an initial phase of cuts and a reassessment before any commitment to moving to perceived neutral; versus the dovish aggressiveness of Chicago's Goolsbee who sees policy as far too restrictive, warranting significant cuts over the next 12 months.
  • Both approaches could get rates from the 4.4% end-2024 Dot Plot median to the 3.4% end-2024 median, rather than derail the easing process altogether - but the more patient approach probably implies a quarterly cadence of 25bp cuts, rather than front-loading at the first half of the year. Implied rates appear to be moving in that direction following the September employment report.