Citi now expects first rate cut in September

Citi economists now expect the Federal Reserve to begin cutting rates in September rather than July, following a much hotter-than-expected May jobs data released last week.

“We now expect 75bp of total cuts this year in September, November and December,” the bank’s economists said in a Friday note.

“But the jobs report does not change our view that hiring demand, and the broader economy, is slowing and that this will ultimately provoke the Fed to react with a series of cuts beginning in the next few months,” they added.

This means that Fed Chair Jerome Powell and the committee are likely to hold off on any decisions in June and July, awaiting more data on slower activity and inflation.

The establishment survey payrolls exceeded expectations, adding 272,000 jobs in May, compared to the consensus of 175,000 and Citi's forecast of 140,000. Government hiring, which had slowed to just 7,000 last month, increased by a solid 43,000 last month. Healthcare hiring also surged, adding 89,000 jobs.

In contrast, the more volatile household survey showed a much weaker performance, with employment down by 483,000 for the month. Despite a 0.2 percentage point drop in the participation rate, the unemployment rate increased by 0.1 percentage point from 3.86% to 3.96%, rounding to an above-consensus 4.0%.

“Fed officials have been very reactive to monthly data – which means today’s payrolls report is enough for them to stay in wait-and-see mode a bit longer,” Citi economists wrote.

However, the constant rise in the unemployment rate and broader deterioration in the labor market will remain an area of concern for the central bank, they added.