US: Brace for Fed easing in 2H. US CPI fell 0.1% m/m in June, in an encouraging sign for the first Fed rate cut to take place in September. The decline from last month was the first time in more than four years that the monthly rate showed a decrease, probably sufficient for the Fed to gain confidence that the downtrend in inflation is intact.

Additionally, the US unemployment rate ticked above 4.0% in June for the first time in this economic cycle. Notably, the household survey has been generally showing a weaker pace of jobs growth over the past year, diverging from the nonfarm payroll (NFP) which draws data from the establishment survey. There has been a steady grind higher in the unemployment rate from a low of 3.4% in early 2023. A gradual cooling of the labour market supports the view that the Fed would cut twice in 2024.

Conditions have aligned sufficiently for the Fed to begin easing in September and this would probably be followed through with another cut in December, taking the Fed Funds rate (upper bound) to 5.00%. We expect the Fed to verbally guide the market towards calibrated cuts at the Federal Open Market Committee meeting in end July.

In any case, the Fed has a dual mandate – full employment and stable prices. As the economic cycle ages, we argue that the employment component would play an increasingly important role. Inflation at 3% (down from as high as 9% in 2022) is no longer that big of an issue. Our Taylor Rule model estimates indicate that the Fed Funds rate is already too restrictive and has been the case for a few months. Recent labour market data is supportive of calibrated easing.

We note that a large proportion of the jobs created appear to be in the government, education, and health services sectors. With signs of weakness in continuing claims, it does seem that parts of the economy may not be doing as well as NFP (which has stayed resilient) suggests. In any case, the ratio of jobs per unemployed persons has dipped to 1.2, consistent with pre-pandemic levels. An inflection point in Fed policy setting is probably upon us.

Download the PDF to read the full report which includes coverage on Credit, FX, Rates, and Thematics.