Nonfarm payrolls "stall," Citi: reasons for rate hikes have "ceased to exist," expects Fed to restart rate cuts in October

The weak June nonfarm payrolls data is fundamentally shifting the Federal Reserve's policy balance.

According to the Chase Trading Desk, Citi Research stated clearly in its U.S. Economic Weekly published on July 2 that the June employment report strongly refutes the necessity of rate hikes. Multiple factors that previously supported a hawkish stance—rising oil prices, accelerating wage growth, and core PCE above target—have now faded. "The case for rate hikes has disappeared," and they maintain their baseline forecast: as the unemployment rate rises in the coming months, the Fed will restart rate cuts in October.

This judgment has a direct impact on the market. If Citi's forecast materializes, the Fed's policy rate range will drop from the current 3.5%–3.75% to 3.25%–3.5% in October, and then to 3.0%–3.25% before year-end.

Nonfarm payrolls significantly below expectations, decline in unemployment rate questionable

June U.S. nonfarm payrolls added only 57k, far below expectations, and the previous two months' data were revised down by a combined 74k. After revisions, the three-month average monthly payroll growth has fallen to about 111k, a sharp drop from the pre-revision level of over 180k.

By sector, leisure and hospitality employment fell by 61k, confirming that the unusual growth in this sector in May was due to seasonal adjustment issues, not World Cup-related hiring demand. Meanwhile, JOLTS data shows that although job openings remain strong, the hiring rate remains low, consistent with the weakening trend in nonfarm payrolls.

Notably, 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%, driven by a steep decline in the 25–34 age group.

Citi believes this is more likely statistical "noise" than a real economic signal—if the participation rate had remained unchanged, the unemployment rate would have actually risen to over 4.5%. As the participation rate is unlikely to fall further and may even rebound, the unemployment rate is expected to rise in the coming months.

Inflation pressures also fading, core PCE may be revised downward

On the inflation front, Citi believes multiple factors are jointly suppressing price pressures. Oil prices have fallen back to pre-conflict levels, and July CPI and PCE data are expected to show month-on-month declines. Further slowing in housing rent will also drag down core CPI and core PCE.

The most important inflation development over the past week was the announcement of a methodological revision to core PCE—the new method applies a more reasonable price adjustment approach to AI-related goods. According to estimates, the year-over-year growth rate of core PCE may be revised down by 20 to 30 basis points, with the revision formally reflected in September.

Combined with the latest forecasts, the year-over-year growth rate of core PCE is expected to gradually decline from around 3.4% currently, to 3.0% by end-2026, and further to 2.1%–2.2% by mid-2027.

Fed Chair neutral, path to October rate cut becomes clearer

On the policy signaling front, Fed Chair Walsh's remarks continued his consistent stance of "not providing forward guidance," explicitly stating he would not comment on data from the past two weeks. Although some market participants interpreted his June FOMC press conference remarks as slightly hawkish, a more accurate characterization is "silent on future policy, thus neutral." Walsh acknowledged in Sintra that inflation risks have declined over the past four weeks and mentioned the potential for AI-driven productivity gains. These comments were "not surprising and clearly not hawkish."

The baseline forecast indicates that the July and September FOMC meetings will see no change, the October 28 meeting will deliver the first 25 basis point rate cut, followed by another 25 basis point cut in December, leaving the federal funds rate range at 3.0%–3.25% by year-end. It also expects three more rate cuts in 2027, with the terminal rate range at 2.75%–3.0%.

In addition, Citi expects U.S. real GDP growth in Q2 to be 1.9% quarter-over-quarter annualized, with consumption contributing 1.3 percentage points and net exports dragging by about 1.2 percentage points. Overall economic growth is slowing, further supporting the logic of the Fed turning to an easing policy.

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