Citigroup believes the weak June U.S. jobs report fundamentally shifts the Federal Reserve's policy calculus. With non-farm payrolls adding only 57,000 jobs, far below expectations, and the three-month average plunging to around 111,000, the bank argues the rationale for further interest rate hikes has disappeared. A decline in the unemployment rate is seen as misleading, driven by a sharp drop in labor force participation rather than genuine strength. With multiple inflation pressures—including oil prices and wage growth—subsiding, Citigroup maintains its base case for the Fed to restart rate cuts in October, followed by another cut by year-end, bringing the target range to 3.0%-3.25%.
Where the Jobs Data Fell Short
The June non-farm payrolls increase of 57,000 was significantly weaker than anticipated, and data from the prior two months was revised down by a combined 74,000. After these revisions, the average monthly job growth over the past three months fell sharply to approximately 111,000, down from over 180,000 previously. The leisure and hospitality sector lost 61,000 jobs, indicating that May's strong growth in the sector was likely due to seasonal adjustment issues rather than World Cup-related hiring. While the JOLTS report shows job openings remain elevated, the hiring rate has stayed low, corroborating the weakening trend in payrolls.
Unemployment Rate Decline Lacks Substance
A notable point is the drop in the unemployment rate from 4.296% to 4.189%. However, this decline was entirely due to a sharp fall in the labor force participation rate from 61.8% to 61.5%, primarily driven by a steep drop in participation among the 25-34 age group. Citigroup views this as statistical "noise" rather than a genuine economic signal. If the participation rate had remained steady, the unemployment rate would have actually risen above 4.5%. The bank expects the unemployment rate to trend higher in the coming months as the participation rate struggles to decline further or potentially rebounds.
Inflationary Pressures Ease Across the Board
On the inflation front, Citigroup sees multiple factors converging to reduce price pressures. Oil prices have retreated to pre-conflict levels, and July's CPI and PCE data are expected to show month-on-month declines. A further slowdown in housing rent prices will also weigh on core CPI and core PCE. A significant recent development was the announcement of a methodology revision for calculating core PCE, which will adopt more reasonable price adjustments for AI-related goods. This revision, set to be implemented in September, could lower the year-on-year core PCE growth rate by 20 to 30 basis points. Based on updated projections, core PCE inflation is expected to gradually decline from the current ~3.4% to 3.0% by the end of 2026, and further to the 2.1%-2.2% range by mid-2027.
The Path to Rate Cuts Becomes Clearer
Regarding policy signals, recent comments from the Federal Reserve Chair maintained a neutral stance, consistent with an approach of not providing forward guidance and declining to comment on recent data. While some market participants interpreted the tone from the June FOMC press conference as hawkish, a more accurate characterization is a neutral position of remaining silent on future policy. The Chair's acknowledgment in Sintra that inflation risks have diminished over the past four weeks and mention of AI's potential to boost productivity were seen as unsurprising and not hawkish.
Citigroup's Policy Outlook
Citigroup's baseline forecast anticipates no policy changes at the July and September FOMC meetings. The first 25-basis-point rate cut is projected for the October 28-29 meeting, followed by another 25-basis-point cut in December, bringing the federal funds target range to 3.0%-3.25% by year-end. The bank further expects three additional rate cuts in 2027, with a terminal rate range of 2.75%-3.0%. Supporting this shift toward policy easing, Citigroup estimates U.S. second-quarter real GDP grew at a 1.9% annualized rate, with consumption contributing 1.3 percentage points and net exports subtracting about 1.2 percentage points, indicating an overall economic slowdown.
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