Nonfarm payrolls "fizzled out", Citi: The reason for rate hikes has "ceased to exist", expects the Fed to resume rate cuts in October

Weak June Non-Farm Payroll data is fundamentally shifting the balance of the Federal Reserve’s policy.

According to Chasewind Trading Desk, in its US Weekly Economic Report released on July 2, Citi Research pointed out that the June employment report strongly refutes the necessity of further rate hikes. Several factors that previously supported a hawkish stance—rising oil prices, accelerated wage growth, and core PCE above target—have all gradually faded. "The rationale for rate hikes has disappeared," and Citi maintains its baseline forecast: as the unemployment rate rises in the coming months, the Federal Reserve will resume rate cuts in October.

This judgment has a direct impact on the market. If Citi's prediction comes true, the Federal Reserve's policy rate range will drop from the current 3.5%-3.75% to 3.25%-3.5% in October, with another cut before year-end to 3.0%-3.25%.

Non-farm Payrolls Fell Sharply Short of Expectations, Doubts Cast on the “Quality” of the Unemployment Rate Drop

In June, the US added only 57,000 non-farm payroll jobs—far below prior expectations—and the data for the prior two months was revised down by a total of 74,000 jobs.After adjustments, the average monthly gain for the past three months fell to around 111,000, a steep decline from the over 180,000 before the revisions.

Breaking down by industry, employment in the leisure and hospitality sector decreased by 61,000, confirming the abnormal rise in May was due to seasonal adjustment issues rather than World Cup-related hiring demand. At the same time, JOLTS data shows that while job openings remain high, the hiring rate continues to slump, corroborating the trend of weakening non-farm payrolls.

It’s worth noting that the June unemployment rate fell from 4.296% to 4.189%, but this decline was entirely due to a sharp drop in the labor force participation rate—from 61.8% to 61.5%—primarily caused by a steep fall in participation among those aged 25-34.

Citi believes this is more likely “statistical noise” rather than a genuine economic signal—if the participation rate remained unchanged, the unemployment rate would actually rise above 4.5%.With the participation rate unlikely to drop further and possibly rebounding, the unemployment rate is set to trend upward in the coming months.

Inflation Pressures Simultaneously Ease, Core PCE May Be Revised Down

On the inflation side, Citi believes multiple factors are collectively depressing price pressures. Oil prices have retreated to pre-conflict levels; July’s CPI and PCE data are expected to fall month-on-month, and a further cooling of housing rent prices will also drag down core CPI and core PCE.

The most significant inflation development this past week was the announcement of a methodological revision for core PCE—a new approach that applies more reasonable price adjustments for AI-related goods. Estimates suggest the revised core PCE year-on-year growth rate could be adjusted down by 20-30 basis points, to be officially reflected in September.

According to the latest forecasts,the core PCE’s year-on-year growth rate is expected to gradually drop from the current 3.4% to 3.0% by the end of 2026, and then further to the 2.1%-2.2% range by mid-2027.

Federal Reserve Chair Maintains Neutral Tone, October Rate Cut Path Growing Clearer

On the policy signal front, Federal Reserve Chair Walsh maintained his longstanding stance of “not providing forward guidance,” clearly stating that no comments would be made on data from the past two weeks. Although some in the market interpreted his June FOMC press conference as hawkish, a more accurate characterization is “remaining silent on future policy, hence neutral.” At Sintra, Walsh confirmed that inflation risk had declined over the last four weeks, and referenced the productivity boost potential from AI—statements that “are unsurprising and clearly not hawkish.”

Baseline forecasts show,the FOMC will stand pat in July and September, implementing the first 25-basis-point cut at the October 28 meeting, and cutting another 25 basis points in December, with the federal funds rate range ending the year at 3.0%-3.25%. It is also anticipated that there will be three more rate cuts in 2027, ending with a terminal rate range of 2.75%-3.0%.

Additionally, Citi anticipates that the US real GDP annualized quarter-on-quarter growth in Q2 will be 1.9%, with consumption contributing 1.3 percentage points and net exports dragging about 1.2 percentage points. Overall economic growth is slowing, further justifying the Federal Reserve’s shift toward looser policy.

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