IGI Logo

Balance of risk in favour of the labour market; Fed eases

The US FOMC’s decision to deliver a 25bps rate cut was well telegraphed and in response to the weakening labour market. This move towards a more neutral policy stance garnered muted market reaction as the US Fed chairman characterised the rate cut as a risk management decision. The call for a steeper rate cut (50bps) by the newly inducted member stood out in the dot plot, raising hopes of an accelerated rate cut cycle, going forward. However, expectations of resilient growth, weak labour market and elevated inflation in the summary of economic projections leave limited room for policy easing. The futures market is building in two more rate cuts by the end of 2025, which, we believe, will narrow to one.

* Shift to neutral with a 25bps rate cut: In a well-telegraphed move, the US FOMC delivered a 25bps rate cut – lowering the range on the policy rate to 4-4.25%. This was not a unanimous decision (11:1), as the newly inducted member Stephen Miran called for a steeper (50bps) rate cut (Ex 2). Both the dissenting members (Michelle W. Bowman and Christopher J. Waller) in the last meeting chose to align with the consensus this time. Fed Chairman Jerome Powell highlighted that with increased downside risk to employment, the balance of risk has shifted. This led the FOMC to move towards a “neutral” stance from what was considered as “modestly restrictive” till now.

* SEP: Resilient growth; weak labour market; elevated inflation: The Summary of Economic projections broadly projects robust growth with further deterioration in the labour market; however, inflation is expected to inch up (Ex 1). The Fed’s expectation of a pickup in GDP growth is in line with the latest GDP nowcasts, indicating that growth is not a challenge although consumption demand is likely to be impacted by tariffs. It is the labour market where the Fed expects further deterioration to 4.5% (unemployment rate) vs. 4.3% currently. Inflationary pressure is expected to inch up as the tariff-led pressure creeps in, mainly in the goods category. The FOMC is not clear whether the impact of tariffs would be one-time or persistent, but Powell indicated that the pass-through has been gradual currently. Prima facie, this scenario will not warrant policy easing, however, with the shift in balance of risk, towards further deterioration in the labour market. Powell characterised today’s policy easing as “risk management” rather than a decision to support the economy.

* Fed prioritises labour market over inflation: The rapid deterioration in the labour market led to the change of policy stance to neutral. Powell indicated that both demand as well as supply of labour had moderated; stricter immigration policy led to the latter. While inflation remains elevated, the impact of tariffs is not meaningful due to a gradual passthrough. Overall, he highlighted that long-term inflation expectations are well anchored.

* Expect a shallow rate cut cycle: We don’t see the shift in stance by the FOMC as a guidance for further policy easing, considering the resilient growth and elevated inflation dynamics. However, the situation could turn in the upcoming policy meetings, hints of which are evident in the dot plot (Ex 2). The calls for an accelerated rate cut cycle can get louder as the influence of newly inducted members increases within the committee. Amidst volatility, market reaction (across asset class) remained muted in response to Powell’s comments characterising the rate cut as a “risk management” decision. The strengthening in the dollar index (96.8) reflects the confidence in Fed’s credibility; however, this will exert pressure on EM currencies. The futures market is building in two more rate cuts by the end of 2025, which, we believe, will narrow to one.

Please refer disclaimer at https://www.jmfl.com/disclaimer

SEBI Registration Number is INM000010361