Employment data replaces inflation as the focus! Federal Reserve's interest rate cut expectations solidify, market bets on three rate cuts within the year

Zhitong Finance APP noted that U.S. Treasury bonds are expected to continue their upward trend, achieving a fourth consecutive week of gains. The unemployment claims data released on Thursday reinforced market expectations that the Federal Reserve will cut interest rates next week.

The yield on the 10-year U.S. Treasury bond rose slightly by 2 basis points to 4.04% (having dropped to a five-month low on Thursday), but it is still expected to decline for the fourth consecutive week, marking the longest consecutive decline since February. The yield on the more rate-sensitive 2-year bond rose to 3.55%.

As the market has fully priced in a 25 basis point rate cut next week, attention now turns to the pace of easing for the remainder of the year. U.S. President Trump has repeatedly expressed a desire for significant rate cuts, but traders remained more cautious until yesterday. Current pricing in the money market indicates an 80% probability of two more rate cuts by the end of the year.

Vincent Mortier, Chief Investment Officer at Amundi, stated: "Given the weakness in the labor market, we believe the Federal Reserve will be obliged to take action—regardless of any political pressure. We still expect three rate cuts this year." The firm is betting on short-term Treasury bonds leading the yield curve to steepen. Other institutions are more cautious, with Allianz and Pacific Investment Management Company indicating they have reduced some curve risk due to the recent gains.

The importance of this week's unemployment claims data overshadowed the August inflation data (2.9%, in line with economists' expectations). The inflation indicator favored by the Federal Reserve is expected to maintain a year-on-year growth rate of 2.9%.

According to a survey, cracks in the labor market may prompt the Federal Reserve to implement a series of rate cuts starting next week over the coming months. The median forecast among respondents indicates two rate cuts by the end of the year, but a significant proportion (over 40%) expects three rate cuts. Among economists expecting two rate cuts, opinions on the timing of the second cut (October or December) are nearly evenly split.

Economists predict further rate cuts in the future

Investors are more inclined to expect three rate cuts this year, with federal funds futures almost fully pricing in this scenario. Nearly 90% of respondents anticipate that Federal Reserve officials will modify their post-meeting statement to emphasize concerns about labor market risks. The new statement will be released at 2:00 PM Washington time on September 17, with Chairman Powell planning to hold a press conference half an hour later.

James Knightley, Chief International Economist at ING, wrote in a submitted comment: "The risk balance surrounding the Federal Reserve's dual mandate (price stability and maximum employment) is shifting to one side, with the labor market becoming a greater concern." The Federal Open Market Committee's July meeting described the labor market as still "robust," but the latest economic data challenges this view The unemployment rate rose to 4.3% in August, with data revisions showing a sharp slowdown in hiring in recent months. Last week's data indicated that the annual average monthly job growth for the year ending in March was also revised down by about half.

Economists are concerned about political pressure.

In his speech at Jackson Hole in August, Powell opened the door for interest rate cuts, stating that "changes in risk balance" may require central bank intervention to prevent a rise in the unemployment rate. Respondents expect that by June 2026, the upper limit of the federal funds rate target range will drop to 3.5%, a full percentage point lower than the current level.

A survey conducted from September 5-10 showed that the vast majority of respondents believe the central bank faces upward risks in both unemployment and inflation. However, only two out of 42 respondents predicted a recession in the next 12 months.

More dissent emerges

Economists expect Powell to face a divided committee next week, with various parties likely to dissent against the anticipated 25 basis point rate cut. A significant proportion of respondents believe that Michelle Bowman and Christopher Waller will dissent again (this time in support of a 50 basis point cut). When the FOMC held rates steady in July, both voted in favor of a 25 basis point cut.

A similar proportion of respondents expect that if Stephen Moore can be confirmed and sworn in as a Federal Reserve governor in time by the Senate, he would also dissent in support of a larger rate cut. In contrast, Kansas City Fed President Jeff Schmid is most likely to vote in favor of keeping rates stable.

Political risks heat up

President Trump has called for a 3 percentage point rate cut from the Federal Reserve while considering candidates for next year's central bank chair. He is also attempting to dismiss Governor Lisa Cook (who is currently fighting the dismissal in court). A judge ruled this week that she can remain in her position during the lawsuit, and the government has appealed this decision.

Against this backdrop, 71% of respondents expressed "some" or "extreme" concern that next year's monetary policy decisions will be influenced by political loyalty. Regarding the Cook case, a slight majority believes that if Trump successfully dismisses her, it would severely undermine the independence of the Federal Reserve.

However, the financial markets have generally reacted calmly to these threats. The yield on 10-year Treasury bonds has recently declined, and market inflation expectations have remained stable. If investors question the Federal Reserve's commitment to price stability, bond yields and inflation will rise. Just over half of economists believe that investors underestimate the political threats to the Federal Reserve's independence.

Tom Fullerton, an economics professor at the University of Texas at El Paso, wrote: "During periods of accumulating inflationary pressure, the easing pressure exerted by the executive branch dangerously approaches triggering stagflation (the coexistence of stagnant economic growth and high inflation)."