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

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The weak June non-farm payroll data is fundamentally changing the Federal Reserve’s policy balance.

According to Chase Wind Trading Desk, Citi Research pointed out clearly in its US Economic Weekly published on July 2 that the June jobs report strongly refutes the necessity of rate hikes. The factors previously supporting a hawkish stance—rising oil prices, accelerated wage growth, and core PCE being above target—have dissipated one after another. “The reasons for raising rates have disappeared,” maintaining the baseline forecast: as the unemployment rate rises in the coming months, the Fed will resume rate cuts in October.

This judgment has a direct impact on the market. If Citi’s forecast comes true, the Fed’s policy rate range will decrease from the current 3.5% to 3.75% to 3.25% to 3.5% in October, and another cut is expected by the end of the year to 3.0% to 3.25%.

Non-farm far below expectations, unemployment rate decline “quality” in doubt

US non-farm payrolls increased by only 57,000 in June, far below previous expectations, and the past two months’ data have been revised down by a total of 74,000. After revisions, the monthly average non-farm payroll increase over the past three months fell to about 111,000, a sharp dip compared to the previous level of over 180,000.

By sector, leisure and hospitality employment declined by 61,000, which confirms that the abnormal growth in May was due to seasonal adjustment issues rather than World Cup-related hiring. Meanwhile, JOLTS data show that although job vacancies remain strong, hiring rates continue to be sluggish, corroborating the trend of weakening non-farm data.

Notably, the unemployment rate dropped from 4.296% to 4.189% in June, but this decline was entirely due to the labor force participation rate plummeting from 61.8% to 61.5%, mainly caused by a sharp drop in participation among those aged 25–34.

Citi believes this is more likely statistical “noise” rather than a real economic signal—If participation stayed unchanged, the unemployment rate would actually exceed 4.5%. As it becomes hard for participation to decline further or may rebound, the unemployment rate is expected to rise in coming months.

Inflation pressures are dissipating, core PCE likely to be revised down

On inflation, Citi believes multiple factors are jointly suppressing price pressures. Oil prices have returned to pre-conflict levels, and July CPI and PCE data are expected to show month-on-month declines; further slowing in housing rents will also drag down core CPI and core PCE.

The most important inflation development in the past week was the announcement of methodology revision for core PCE—new methods adopt more reasonable price adjustments for AI-related products. Estimates suggest the revised core PCE year-on-year growth rate may be cut by 20–30 basis points, to be officially reflected in September.

Based on latest forecasts, the year-on-year growth rate of core PCE is expected to gradually decline from the current level of about 3.4%, fall to 3.0% by the end of 2026, and further drop to the 2.1%–2.2% range by mid-2027.

Fed Chair’s stance is neutral, October rate cut path becomes clearer

In terms of policy signals, Fed Chair Walsh’s speech maintained his usual “no forward guidance,” clearly stating that he would not comment on data from the past two weeks. Although some market participants interpreted his remarks at the June FOMC press conference as hawkish, a more accurate characterization is “maintaining silence on future policy, thus neutral.” Walsh confirmed at Sintra that inflation risk has declined over the past four weeks and mentioned the productivity potential brought by AI. These comments are “not surprising and clearly not hawkish.”

Baseline projections show that the FOMC meetings in July and September will stand pat; the meeting on October 28 will see the first rate cut of 25 basis points, and another 25 basis point cut in December, leaving the federal funds rate range at 3.0%–3.25% by year-end. Additionally, it is expected that there will be three more rate cuts in 2027, with the terminal rate range at 2.75%–3.0%.

Moreover, Citi expects US real GDP annualized quarter-on-quarter growth of 1.9% in Q2, with consumption contributing 1.3 percentage points and net exports dragging about 1.2 percentage points. Overall economic growth is slowing, which further supports the logic for the Fed to turn dovish.

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